Are these income stocks getting too expensive?
With the FTSE 100 trading at a record high, it is perhaps unsurprising that some shares appear to be overvalued. Investors are relatively bullish and optimistic about the future at the moment, so it is understandable that some valuations will have become unattractive. With that in mind, here are two shares which could be worth avoiding at the moment. They may have impressive dividend yields, but could lack capital growth potential.
Improving performance
Reporting on Thursday was ingredients specialist Tate & Lyle(LSE: TATE). The company's full-year results showed progress has been made, with its adjusted pre-tax profit figure moving 20% higher. Both of its key divisions delivered good growth rates, with Bulk Ingredients increasing its adjusted operating profit by 32%. It was buoyed by strong commercial and manufacturing performance. Similarly, Speciality Food Ingredients recorded a rise in adjusted operating profit of 5%, with margin expansion being a positive feature of the year.
In terms of its income prospects, Tate & Lyle's dividend yield of 3.6% is relatively attractive. Although 20 basis points lower than the FTSE 100's yield, it is nevertheless relatively well-covered by dividends. In the financial year just ended, dividends were covered 1.9 times by profit. This indicates that a higher dividend could be warranted in future without putting the company's growth outlook or financial stability under pressure.
Despite this, Tate & Lyle seems to be relatively overvalued at the present time. It trades on a price-to-earnings (P/E) ratio of 14.1 and yet is forecast to record a rise in its bottom line of just 4% in each of the next two financial years. Therefore, while it does have some income appeal for the long run, its share price growth could lag the wider index over the medium term.
High valuation
While the property sector faces a relatively uncertain outlook, property investment and development company Newriver Reit(LSE: NRR) appears to have a rather generous valuation. For example, it trades on a P/E ratio of 15.5 and yet is expected to report a fall in earnings of 5% in the current year. Certainly, its price-to-book (P/B) ratio of 1.2 may not be exceptionally high. However, at the present time a number of property-focused stocks offer either lower valuations or superior growth outlooks for the medium term.
Of course, Newriver Reit remains a relatively attractive income stock. It currently has a dividend yield of 6.2%. While dividends are only just covered by profit, property stocks do not generally require the same level of reinvestment for future growth as stocks in other sectors. Therefore, while dividend growth may be limited because of a potentially challenging outlook for the sector, the company's current shareholder payout may prove to be sustainable.
However, with superior options within the same sector, there may be better opportunities for investors to generate a high return in the long run.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.
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