Three income-producing UK stocks

With UK gilts offering record low yields, investors are right to search for income, says professional stock picker Stuart Widdowson. Here, he tips three high-yielding stocks to buy now.

Each week, a professional investor tells MoneyWeek where he'd put his money now. This week: Stuart Widdowson, investment director, SVG Investment Managers.

With ten-year UK gilt yields at a multi-decade low and offering a negative real (after-inflation) yield, investors are right to look at UK equities in the search for income. During the first half of 2012, UK quoted companies paid out £41.4bn in dividends, a rise of 21% compared with the first half of 2011.

Dividends are forecast to increase by 15% overall in 2012. The 4.3% yield for the FTSE All-Share index is also covered 2.5 times by earnings and more than three times by cash flow. This suggests it can be sustained. Over the past four years, UK companies have also significantly reduced their borrowings and hence the risks for equity investors.

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In addition to sustainable, high and growing dividend yields, we believe that UK equities offer capital gains driven by moderate earnings growth, continued debt reduction, and mergers and acquisitions. UK equities are priced at just 9.3 times future earnings, a big discount to the ten-year average of 14.2 times.

The ten largest companies generate about 50% of all UK dividends. However, such a concentration of income can create risks for investors as BP's Deepwater woes and suspended dividend illustrated. So we believe there are good opportunities to invest in a basket of small and mid-sized companies, generating a growing dividend yield of more than 4% with good earnings prospects and strong balance sheets. Many of these companies are trading on undemanding valuations. Here are three to consider.

4imprint (LSE: FOUR) is the largest promotional products direct marketer in North America. It has grown sales by 15% a year since 2006, over which time its end market has been flat. With only around 1% market share in this highly fragmented $20bn market, we believe its superior business model will continue to deliver many years of growth in excess of GDP. It is forecast to have £12m of cash on the balance sheet at the year end equivalent to about 16% of its market capitalisation. The dividend yield is 5.6%, and growing.

BBA Aviation (LSE: BBA) is a global provider of aviation services and aftermarket spares and products, predominately serving the business jet market. It operates from 200 locations worldwide, a big proportion of which are in North America. It is often the sole supplier for its services in each location.

Activity levels in its markets continue to improve slowly from the trough of 2009, but remain significantly lower than the peak of 2006/7. It is strongly cash generative and has paid down significant debt since 2009. The firm trades on a price-to-cash-flow ratio of 7.1 times and yields 4.6%.

Daily Mail and General Trust (LSE: DMGT) is a UK media conglomerate, operating from 40 countries. Although best known for publishing the Daily Mail, around 75% of operating profits are derived from its growing business-to-business media interests. The shares have been de-rated lately due to their exit from the FTSE 250 index, driven by changes to the way the index is calculated. However, a sum-of-the-parts valuation suggests considerable upside to the current share price. The shares yield 4.1%, covered 2.5 times by earnings. It is modestly geared and is continuing to rapidly pay down its debt.

Stuart Widdowson

Stuart is a professional investor and Managing Partner at Odyssean Capital LLP. Prior to this, Stuart was a fund manager of strategic funds at GVQ Investment Management Limited for just over 10 years and then he spent 6 months as a partner at Harwood Capital to establish a new fund management business. He has been at Odyssean Capital LLP for just over 5 years and he has contributed to MoneyWeek’s share tips.