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National Grid (LSE: NG) shares have hit record highs this year as investors have backed the company’s shift from gas towards electricity.
However, National Grid’s share price has slipped back recently, despite a strong set of annual results. A lower share price means a higher dividend yield, so I wonder if now could be a good time for me to add this FTSE 100 dividend stock to my portfolio.
A record year
National Grid invested £6.7bn in its energy infrastructure last year, a new record for the business. The group also completed the £7.9bn acquisition of UK distributor Western Power Distribution and sold a 60% stake in its UK gas business.
Chief executive John Pettigrew is making these changes to try and ensure that the FTSE 100 group profits from growing electricity consumption. This new strategy should also help to protect shareholders from the risk of falling profits due to lower gas demand.
It’s too soon to be sure how well this plan will work. But the company’s earnings are also getting a boost from higher inflation. This contributed to a 16% rise in National Grid’s underlying pre-tax profit to £3,059m last year.
Shareholders got a pay rise too. National Grid’s dividend rose by 4% to 51p per share, giving the stock a 4.6% yield.
How safe is the NG dividend?
I’ve followed National Grid for a number of years. Before the pandemic, I was starting to worry about the safety of the utility group’s dividend. Slowing growth meant that dividend cover was shrinking. I thought a cut might be needed.
I’m not worried now. The shift to electricity should mean faster growth in the future, as electric consumption replaces gas usage. This should translate into faster earnings growth, supporting higher dividends.
The main risk I’d highlight is that I’m not sure National Grid will be able to hit its goal of matching dividend growth with inflation.
UK CPIH inflation (the measure used by the company) is currently 7.8%. Broker forecasts suggest National Grid’s dividend will rise by 3.8% this year and 3% next year. Unless inflation starts to ease fairly soon, I think the real value of NG’s dividend could fall.
Are National Grid shares a good buy now?
The shares offer a forecast dividend yield of 4.7% for the current year. That’s comfortably above the FTSE 100 expected yield of around 3.5%
However, while I’m tempted by the above-average yield, I feel more cautious about the stock’s valuation. As a large utility, I don’t expect this business to be a fast grower.
I’m also wary that if inflation stays high and interest rates continue to rise, investors are likely to demand higher yields. That could push National Grid’s share price down further.
My sums suggest that the shares are probably quite fully priced at the moment. To buy them today, I’d want a dividend yield of at least 5%. That suggests a share price closer to 1,000p, rather than the current 1,100p+.
For a long-term income investment, securing a good entry price with an attractive yield is important.
I think there could be better opportunities to buy National Grid over the coming months, so I’m going to stay patient for now.
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