The Income Investor: FTSE 100 income appeal amid the chaos

An ongoing global trade war may naturally encourage income investors to retreat from dividend stocks. After all, the imposition of varying levels of tariffs by the US could have a negative impact on global GDP growth. It may also lead to further retaliation from various countries affected by tariffs that additionally weighs on the world economy’s prospects.

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Trade barriers, moreover, create additional uncertainty regarding inflation and interest rates. While inflation has been sticky over recent months, it was widely expected to gradually fall across the developed world over the medium term. This would have provided scope for central banks such as the Bank of England to further reduce interest rates, thereby providing a boost to the economy, company performance and, ultimately, dividend growth rates.

However, the path to monetary policy easing is now arguably more opaque as the prospect of a lengthy trade war comes sharply into focus. This may understandably lead income seekers to favour cash over shares, given the latter’s potential for paper losses and dividend cuts amid a turbulent period for the world economy and stock markets.

The appeal of income stocks

Dividend-paying stocks, though, could still offer superior long-term income investing appeal versus cash. After all, the world economy has an excellent track record of recovering from even the most challenging circumstances. For example, in the past couple of decades it has bounced back from the global financial crisis and the pandemic to post strong levels of GDP growth. This should mean that, while dividends and share prices could come under further pressure in the short run, they are highly likely to resume their long-term growth trends in the coming years.

Periods of elevated uncertainty can, moreover, provide opportunities to purchase high-quality income shares at a discount to their intrinsic value. This may not only allow income investors to obtain a more generous yield than would normally be possible, it can also provide them with scope to generate a relatively attractive capital gain over the coming years.

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Clearly, cash offers greater stability than dividend stocks in the short run. It also has a relatively attractive income return at present, with it being straightforward to obtain an interest rate upwards of 4% on easy access cash savings. However, many accounts have started to reduce rates and the long-term track record of cash lags that of a diverse portfolio of dividend stocks. Therefore, income seekers with an extended time horizon may find that holding too much cash ultimately proves detrimental to their overall returns.

Source: Refinitiv as at 8 April 2025. Bond yields are distribution yields of selected Royal London active bond funds (as at 28 February 2025), except global infrastructure bond which is 12-month trailing yield for iShares Global Infras ETF USD Dist as at 4 April. SONIA reflects the average of interest rates that banks pay to borrow sterling overnight from each other (4 Apr). *Data prior to May is based on 3-month GBP LIBOR. Best accounts by moneyfactscompare.co.uk refer to Annual Equivalent Rate (AER) as at 8 April. **Best rate includes 3-month bonus.

Defensive business models

Of course, different companies will be affected to varying degrees by the ongoing global trade war. For example, cyclical firms that are highly reliant on the economy’s performance are likely to be impacted to the greatest extent by elevated uncertainty and the prospect of a slowdown in GDP growth. Conversely, defensive companies that are less reliant on the world’s economic outlook may still be able to deliver a solid financial performance which enables them to raise shareholder payouts over the medium term.

Income investors may, therefore, wish to consider how reliant a company is on the economy’s performance before buying it. Those investors who require a relatively stable and reliable income could find that defensive shares are more attractive than cyclical stocks given the likelihood of continued economic uncertainty.

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In any case, the imposition of trade barriers means that income seekers should continue to select only those dividend stocks which have solid fundamentals. Firms that have a sound balance sheet, for instance, are more likely to overcome challenging trading conditions caused by economic uncertainty. Similarly, those companies which have a clear and sustainable competitive advantage may be able to deliver superior performance than their peers during an economic downturn.

In addition, businesses that have modest payout ratios may be less likely to cut dividends should their profitability come under pressure. And, as ever, purchasing stocks that offer a wide margin of safety, such as via a relatively high dividend yield or low price/earnings (PE) ratio, may provide a more attractive risk/reward opportunity for long-term investors.

An attractive yield

Tobacco stock Imperial Brands (LSE:IMB), for example, currently has a dividend yield of 6%. This is around 200 basis points greater than the FTSE 100 index’s yield and is relatively high despite the company’s strong share price performance over recent months. In fact, the stock’s price has risen by 48% since it was first discussed in this column during December 2023. The FTSE 100 index has gained 4% over the same period.

The company’s dividends have risen at an annualised rate of 3.3% over the past three years. The firm appears to be well placed to deliver further growth in shareholder payouts despite the presence of an increasingly uncertain economic environment because of its defensive business model. Indeed, demand for tobacco products is typically relatively unaffected by economic undulations due to its status as a staple item.

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Moreover, the company’s latest trading statement showed it is making encouraging progress in implementing its current strategy. As part of this, it will focus investment on its five largest geographical markets and will seek to deliver annualised cost savings of £320 million by the end of 2030. When combined with the impact of an ongoing share buyback programme, this means the firm expects to deliver a high single-digit annualised increase in earnings over the medium term that could provide scope for a higher dividend.

Currently, the firm’s shareholder payouts are covered a healthy 1.9 times by profits. This suggests that a large proportion of bottom-line growth could realistically be passed on to investors via a higher dividend. As a result, it would be unsurprising if shareholder payouts grow at a faster pace than inflation over the coming years.

Risk/reward opportunity

Clearly, Imperial Brands continues to face an uncertain future as a result of longstanding regulatory risks. It may also be negatively affected by changing consumer tastes, with the firm being relatively reliant on cigarette sales that could come under pressure as individuals become increasingly health conscious. Indeed, sales from its next generation product portfolio (which includes e-cigarettes) accounted for just 4% of its total revenue in the latest financial year.

However, the company’s strong market position means that it can potentially offset the impact of a moderation in demand via price rises. Moreover, investors appear to have factored in potential threats to the company’s financial performance. Even after its aforementioned share price rise, it trades on a forward PE ratio of just 8.6. This suggests that it offers a wide margin of safety, as well as scope for substantial capital gains. In fact, when combined with its forecast high single-digit growth in earnings over the medium term, the stock’s rating indicates that it is significantly undervalued.

Although the company’s net debt-to-equity ratio of 133% is relatively high, its net interest costs were still covered more than six times in the latest financial year. Moreover, the company’s defensive business model is likely to produce a relatively stable financial performance that allows it to carry higher debt levels vis-à-vis a more cyclical firm.

Therefore, with a mixture of solid fundamentals, upbeat growth potential and a low market valuation, the stock appears to offer a favourable risk/reward opportunity. Its attractive yield, scope for dividend growth and defensive business model amid elevated economic uncertainty, suggest it could prove to be a worthwhile income investing opportunity for the long run.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.