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A Dividend Pick Across the Pond

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. You have until April 15 to fund an IRA for the 2009 tax year. So, all this week, we'll be talking to some of Morningstar's experts to get their best ideas for funding an IRA.

I'm here today with Josh Peters. Josh is editor of Morningstar DividendInvestor, and he's Morningstar's resident dividend guru guy. So Josh, thanks for being here.

Josh Peters: [laughs] Happy to be here. Somebody has to be the dividend guru guy, right?

Benz: So, Josh, you've got an income centric pick, as usual. What's your best idea, and why do you like it?

Peters: Well, I don't have a whole lot of good ideas to pick from right now. Markets have come up a lot.

Benz: Market's kind of rich...

Peters: And dividend yields are hard to find. But by poking my head outside of the U.S., I have one company that I like quite a bit. It's called National Grid. Ticker symbol is NGG. They are kind of an interesting mix of utilities.

They operate all regulated utilities, just transmission and distribution, no generation, or energy exploration, or anything like that. But it's got a roughly 50/50 split between utilities in the northeastern United States and in the U.K., where they operate the national electricity grid.

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Benz: So what do you think are the attractions of this business? Because I know that's a key thing you think about when looking to build positions for the long haul.

Peters: Well, you think about investing for an IRA, you're looking down the road a way. So my general emphasis would be to look for stories that can give you a lot of income and a lot of total return. That in turn you can use that income to compound, produce something that looks a lot like growth without necessarily having to be growth of the underlying business.

Because valuations are relatively high still, in a historic context. Dividend yields are very low. Interest rates are very low, but that would seem to leave only one direction for them to go. If we are in this "new normal environment" of low economic growth, then stocks that are priced to need a lot of growth are going to disappoint. A company like National Grid, with a yield close to 6%, if its dividend can even just grow at the rate of inflation, it's going to be a rewarding investment.

In fact, we think National Grid could be raising its dividend by 5, 6, maybe even 8% a year, for many years to come. Their regulatory framework, that they're regulated under, is just so favorable, really, on both sides of the Atlantic.

Benz: So what are the key risks, at this juncture, that you see?

Peters: Well, it's funny. I just mentioned interest rates a little bit ago. Because rising interest rates do tend to be negative for utility stocks. However, I don't think utility stocks in general are priced for 0% short-term rates today. I think that there's some room for rates to move up and normalize before utility stocks would really start to lose their attractiveness.

And also, looking out over a long period of time, the income you're going to collect from this, over a five-, 10-, 20-year period is really just going to be so large in relation to current share price that even if it dips for a little, who's really going to care after that many years pass by?

The real specific risk to National Grid, relative to say utilities that are only in the United States, is what happens to the British economy? It has got a very high budget deficit right now, high unemployment, a very weak recovery under way. Perhaps one of the weakest in the industrialized world.

The way I think about it is this. Like a utility in the United States, this utility in Britain is really insulated from most of what goes on in the economy. The big risk is currency. What if the pound continues to drop? Or the country tries to devalue to lessen the burden of some of its external debts.

If that happens, inflation probably goes up in the U.K. If that happens, then in turn, utility rates are actually tied to inflation in the U.K. So you get an automatic pass-through to revenues and to earnings that can really act as a good long-term natural hedge, from the standpoint of a U.S. investor. It's not a perfect hedge, but a very good one, if you have the opportunity to give it time to work.

Benz: So you think the margin of safety is there? And that's what you seek, ultimately, with every investment that you recommend?

Peters: Yeah, I'm looking for low risk investments in general, but I also want to think about what could go wrong, even in what looks like a low risk situation. And paying less and getting a good yield up front is a good way to insulate yourself from those risks.

Benz: OK, Josh, thanks for the great idea.

Peters: Very happy to be with you here today.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.