Should you buy the 2 highest-yielding stocks in the FTSE 100?

The Motley Fool
Pearson, teacher educating schoolkids
Pearson, teacher educating schoolkids

With UK interest rates having fallen to just 0.25%, income stocks are likely to become more popular. That's especially the case since inflation has already risen to 1% since the EU referendum, which could mean that assets such as cash and bonds offer negative real returns over the medium term. So now could be the right time to buy the FTSE 100's two highest yielding shares.



With a yield of 6.9%, Pearson(LSE: PSN) is currently the second highest yielding stock in the FTSE 100. Its yield is almost twice the 3.6% yield of the index and offers a stunning income return for investors.

However, Pearson is enduring a challenging period right now. It is experiencing difficult operating conditions and its bottom line is expected to decline by 21% in the current year. This will put its dividend under pressure since it will be covered only 1.1 times by profit. For a business that has not historically been the most stable, this should be a cause for concern for potential investors in Pearson.

Despite this, I think Pearson is worth buying for its income prospects. It has a turnaround plan that is likely to make a positive impact on its financial performance, starting with next year when Pearson is forecast to record a rise in earnings of 16%. This would help to boost its dividend coverage ratio to 1.25, which is relatively healthy compared to its index peers.

Certainly, Pearson lacks dividend growth in the short run, but if its new strategy does work out as planned then a brisk dividend rise which stays ahead of inflation is on the cards. Added to its super-high yield, I think this makes Pearson an excellent long term income play.

Legal & General

The highest yielding share in the FTSE 100 is currently Legal & General(LSE: LGEN). It yields 7% and its dividend could be set to rise further at a rapid rate. That's because Legal & General's shareholder payouts are covered a healthy 1.5 times by profit. This indicates that dividends could rise at a faster pace than profit and still leave Legal & General in a very sound financial position.

Furthermore, Legal & General is forecast to increase its bottom line by 14% over the next two years. This should positively catalyse dividends and with Legal & General expected to increase dividends per share by 5.6% in 2017, a higher rate of inflation is unlikely to be of much concern to its investors. And with the company increasing its return on equity to over 20% and its net cash generation up by 16% in its most recent half-year results, Legal & General's current strategy appears to be working well.

Clearly, both Pearson and Legal & General could be subject to short term volatility as the combination of a US interest rate rise, the US election and on-going Brexit uncertainty could cause investor sentiment towards the stock market to come under pressure. However, for long term income investors, I think they are both strong buys right now.

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Peter Stephens owns shares of Legal & General Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.