Look at any investor’s list of potential dividend candidates and energy company National Grid (LSE: NG) is a stock likely to be near the top.
But when researching and considering the company, it presents investors with a dilemma.
Defensive operations
On the one hand, the business ticks all the boxes for operating in a defensive sector with potential for generating reliable cash flows. Indeed, energy usage doesn’t vary that much, even in economic recessions.
And that situation contrasts with some of the cyclical business that often tempt us with their high yields. But when the economy turns downwards and people start tightening their belts, cyclical companies can see a drop in revenue, earnings and cash flow. And that often results in plunging dividends and falling share prices.
But National Grid’s defensive characteristics are rock solid. And that’s because of the monopoly in its transmission grid operation. But it also enjoys geographical monopolies in its distribution operations in the UK and the US.
However, on the other hand, the company’s monopolies come at a cost. And that’s in the form of super-stringent regulation on both sides of the Atlantic. Service levels and infrastructure standards must be maintained. And regulators require National Grid to invest ongoing millions into looking after and improving its systems.
And that’s the dilemma. Regulators are all-powerful. And it’s possible that their requirements can become so severe that it becomes difficult for National Grid to maintain the level of its dividend payments.
Perfection doesn’t exist
If it wasn’t for that risk hanging over the investment proposition like the Sword of Damocles, I’d consider National Grid to be a perfect dividend stock.
However, perfection doesn’t exist. And all shares carry risks and investors must embrace them to invest in anything. So although National Grid isn’t perfect, I still believe it to be a very good dividend-paying share.
And the yield right now is attractive. With the share price near 1,051p, the forward-looking yield for the trading year to March 2025 is around 5.6%.
But on top of that, the multi-year financial record shows steady, incremental annual increases in the shareholder payment. And the compound annual growth rate is running just below 4%.
However, the record on cash flow is just as impressive and it’s done a good job of supporting the dividend for many years. And, looking ahead, I think the situation looks set to continue, despite my ongoing angst about the power of the regulators.
So in some ways, I reckon National Grid is pretty close to being a no-brainer stock for dividend investors.
But I’d aim to mitigate the risks of holding the shares by adding the business to a diversified portfolio of several dividend-paying stocks.
There are never any guaranties of positive investment outcomes. But I reckon dividend investing’s a strategy that’s well-starred to succeed. And National Grid is a decent candidate to consider right now.
