At the time of writing, shares in BT (LSE: BT.A) are dealing at a forward P/E of just 7.8, supporting an attractive dividend yield of 7.8%. For income investors, this level might be too hard to pass up, but I think you should stay away.
You see, I’m sceptical BT can maintain its current dividend because the telecoms giant needs to invest more to grow its business and retain customers. This is something management has commented on as well. Back at the beginning of July, chairman Jan du Plessis said management will consider reducing the dividend in “a year or two in the future” depending on its capital expenditure commitments.
The company says it will also look at cutting costs and borrowing more to help fund the expansion of its fibre broadband network over the next few years. BT’s promise to bring full-fibre broadband to 15m two households across the UK will cost between £400m and £600m a year, according to its own forecasts.
With the threat of the dividend cut hanging over the BT share price, I don’t think it’s worth buying the shares at current levels. As well as the threat of a dividend cut, there’s also the company’s high level of indebtedness to consider, ginormous pension deficit (bigger than the market capitalisation of most FTSE 100 firms), and competition.
So, I would forget the BT share price and invest my money instead in UK insurance group Admiral (LSE: ADM). Compared to BT, I think Admiral is firing on all cylinders. The company is expanding its presence at home here in the UK, and investing heavily in growing out is overseas businesses. These are expected to break even for the first time in the next year or so.
These overseas businesses, coupled with the fact Admiral is one of the most efficient general insurance companies in the country, are the reasons why I like this business so much. Specifically, Admiral’s return on equity — a key measure of profitability — was 56% for its 2018 financial year. Its closest competitor, Direct Line, reported a return on equity of just 18%.
Admiral is also branching out into financial services, having recently launched a loan product. This division is still unprofitable, but it is yet another string to the company’s bow that will help power growth in the years ahead.
Admiral is hugely profitable, and the company is returning the majority of its excess profits to investors with dividends. The company tends to pay out a combination of both regular and special dividends, which analysts believe will total just under 130p per share for 2019. Based on this forecast, the stock supports a forward dividend yield of just under 6%.
So overall, Admiral’s dividend yield is lower than the level of income offered by BT, but I believe the company’s growth prospects are vastly more attractive. That’s why I would forget the BT share price and buy Admiral for my portfolio today instead.
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Rupert Hargreaves owns shares in Admiral Group. The Motley Fool UK has recommended Admiral Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019