The UK’s bias towards defensive, dividend-paying stocks has meant that despite global stock market volatility, the Morningstar UK Index has returned around 8% in sterling terms so far this year.
As part of income week on Morningstar.co.uk, income fund managers at Rathbone and JP Morgan highlight their preferred UK dividend-paying stocks. UK inflation is forecast to have risen to 3% in April, so each stock featured here has a dividend yield above this level, and two are expected to increase their dividends in the coming years.
National Grid and Green Energy Spending
Alan Dobbie, co-portfolio manager of the Rathbone Income Fund, which has a Silver Medalist rating, likes National Grid NG.. The UK electricity infrastructure stock, which has the highest weighting in the Rathbone fund, has an “exciting growth angle”, Dobbie argues. The assumption is that many dividend payers in the UK are “ex-growth”, preferring to distribute excess cash to shareholders.
But Dobbie says there is a secular trend behind the shares, that of the upgrades necessary to support the UK’s net zero ambitions.
“The UK electricity transmission network is in desperate need of and is going to get significant investment over the coming years. Most of that will be done by National Grid. What [the UK] has not done is ensure the grid is in fit enough shape to take [renewable energy] from where its generated to where it needs to get to. We are kind of playing catch up there,” he says.
National Grid recently announced that it will double its investment over the next five years across the UK and the US to £60 billion. The five-year strategic plan will be mainly driven by the UK transmission network, which needs to connect onshore and offshore wind farms to the electricity grid.
The company currently has a dividend yield of 5.23%. In 2024 National Grid paid a dividend per share of around 54p, up from the 52p it paid in 2023, and the 47p it paid in 2022.
Despite its high yield credentials, Tancrede Fulop, senior equity analyst at Morningstar, says that its recent decision to “rebase” its dividend means a cut for investors.
“The dividend per share will be rebased on the new number of shares, involving a 26% drop in fiscal 2025 versus 2024. This is a turning point since the firm has been increasing the dividend every year since 1998,” he says.
According to Morningstar analysis, the stock is overvalued, trading in 2-star territory. National Grid’s shares are currently trading at £10.57 over Morningstar’s fair value estimate of 970p. So far this year the stock is up over 10%. In results issued on May 15, pretax profit rose 20% to £3.65 billion in the year to March 31 from £3.05 billion a year prior.
NatWest is Growing Dividends
Katen Patel, co-portfolio manager of the JP Morgan UK Equity Income fund, favors UK bank NatWest NWG because of its above market dividend yield. The fund has a Morningstar Medalist Rating of Neutral and the stock is the fourth biggest holding.
The UK bank’s current dividend yield is 4.25%, slightly above the overall average for the UK stock market of 4%. However, Patel argues that NatWest’s dividend is set to grow significantly over the coming years.
“NatWest used to pay around 30% of earnings in dividends and they are going to increase the amount. So, between 40% and 50% this year, which is obviously leading to higher dividend yields for the company. On current estimates next year, we could see it paying almost 6.5%, which could grow to 7% in a couple of years based on market forecasts,” he says.
After a long period of not making any payouts, NatWest’s dividend has grown over the years. Its final dividend for 2024 reached 15.5p, up from levels in 2023 of 11.5p and 2022’s payout of 10p per share. However, according to Morningstar analysis, the stock is overvalued, trading in 1-star territory.
Patel agrees that NatWest and other UK banks have benefited from lending at higher interest rates after a sharp rise in borrowing costs from 2022 onwards.
In his view, the bank has resolved the legacy issues from the global financial crisis, which has allowed the business to focus on balance sheet growth, and to have more spare cash to distribute to shareholders as dividend payments.
NatWest is about to return to full private ownership after 16 years of UK state control.
Dunelm Growing Market Share
JP Morgan’s Patel is also bullish on British house furnishing retailer Dunelm DNLM, which is a growth and income play.
“Dunelm has gone from 5% market share to up to 7.5% of the homewares and furniture market. It aims to grow this up to 10%. They have taken market share from lots of smaller independent players,” he says.
In his view the company has been conservatively run and does not have huge amounts of debt on its balance sheet, which has allowed it to pay attractive dividends to shareholders.
According to JP Morgan’s Patel, over the last 20 years the dividend has grown on average 8% a year. The company is currently yielding 3.73%. In 2024 it paid a final dividend of 27.50p, beating 27p in 2023 and 26p in 2002.
For the full year 2024, Dunelm reported a profit before tax of £205 million, up from 2023’s levels of £193 million. Shares are up 13% so far this year at £12.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
