Since inflation is forecast to rise to almost 3% in 2017, finding stocks yielding more than that amount could prove crucial. If inflation is higher than a stock's yield, then it could mean a negative yield in real terms.
As ever, finding stocks with a wide margin of safety could be a sound move, which is why buying shares with yields of 5% or more could be a prudent step to take. Here are two examples which offer just that, plus dividend growth potential.
An oil & gas turnaround
While the oil price decline of recent years left many investors feeling panicked, BP(LSE: BP) has continued to operate in a similar fashion to that in which it has always has done. Certainly, it has sought to become more efficient and reduce its cost base. But it has generally maintained dividends, invested in its future growth prospects and remained optimistic about the long term direction of the oil price.
In terms of its dividends, BP currently yields 6.5%. That's almost 3% higher than the FTSE 100 and at least 3.5% more than inflation expectations from the Bank of England for 2017. As such, the chances of having a negative real yield from BP are slim. While there has been concern that the company's dividends will not be covered by profit due to the low oil price, since OPEC's production cut, the prospect of a rising dividend is much higher.
In fact, BP's earnings are due to rise by 135% this year and by a further 22% next year. This means shareholder payouts are expected to be covered 1.2 times by profit next year. This indicates that they are sustainable and could even increase. Of course, this is dependent on the oil price, but with reduced production across the industry BP now appears to be a highly attractive dividend stock.
Dividend growth potential
While Legal & General's (LSE: LGEN) yield of 6.3% is not quite as high as that of BP, it could be argued it has greater dividend growth potential. Part of the reason for this is its relatively stable business model which has delivered consistent profit growth in recent years. For example, in the period 2012-2016, Legal & General's earnings have risen by more than 50%. This has provided it with the opportunity to raise dividends by over 100% during the same time period.
Looking ahead, there is more scope for a rise in shareholder payouts. Legal & General currently pays out around 70% of profit as a dividend. Therefore, there is sufficient headroom when making dividend payments to ensure the current payout ratio is sustainable. And with further growth in earnings forecast in 2017 and in 2018, it would be unsurprising for the company's dividend to rise by more than inflation.
While a number of financial services and banking stocks also offer high yields, Legal & General's business model has been shown to be highly resilient and relatively predictable. Therefore, it seems to offer a high yield, dividend growth potential and a relatively low risk profile.
But could buying either stock prove to be a mistake?
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Peter Stephens owns shares of BP and Legal & General Group. The Motley Fool UK has recommended BP. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.