Three stocks for sustainable income

With evidence of a 'double-dip' all around, economic growth is likely to be weak at best in the coming months. So where should investors focus? Professional investor Sandy Cross looks for companies that generate sustainable income. Here, he tips three of his current favourites.

Each week, a professional investor tells MoneyWeek where he'd put his money now. This week: Sandy Cross, head of Standard Life Wealth's Edinburgh office.

Evidence of a 'double-dip' has been cropping up everywhere from the housing market to employment figures. Fiscal tightening is underway in the developed world and government debt levels still look lofty. Economic growth seems likely to be fairly weak, even if a return to recession is avoided. We expect this environment to drive volatility in markets. So where should investors focus?

Sustainable income has been an ongoing theme within our portfolios. This still looks very much the right approach given the volatility we expect to be a continuing feature of the markets. In the case of equities, sustainable income streams really do seem to support long-term performance. That makes sense if you subscribe to the view that a company's value is the sum of current and future cash flows (clearly, a key word here is sustainable as many investors in struggling UK banks will testify). Consistent real cash flow is an eloquent demonstration that a business's management believes it can and will deliver more of the same.

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In order to achieve real dividend growth the key goal for a long-term income investor managers need to be disciplined in how they allocate capital and spend shareholders' money. London Business School academics Dimson, Marsh and Staunton, writing in the Credit Suisse Global Investment Returns Yearbook 2010, produce some interesting market analysis. This shows a strikingly high positive correlation between real equity returns and real dividend growth for the period 1900-2009 in the 19 countries studied. UK equity income investors have had a rough patch over the last couple of years, with bank dividend cuts and the BP debacle. Nonetheless, long-term evidence supports the idea of income as a driver of returns. So how do we think investors should access equity income growth? Here are four suggestions.

For a broad income play, there's the the Artemis Income Fund (tel: 0800-092-2051). It has two tried and tested managers at the helm, with a long experience of investing in companies with growing dividend streams.

In terms of direct equity holdings, I am quite optimistic about the outlook for the pharma sector. There are some interesting new compounds in prospect for the major companies after a relentless barrage of patent-expiry bad news. I also rate the inbuilt value of these firms' marketing franchises. For example, GlaxoSmithKline's (LSE: GSK) range of activities also includes major vaccine and consumer healthcare businesses which produce consistent returns. The stock yields a little over 5% and growth in the dividend is forecast.

Meanwhile, BT (LSE: BT.A) has many things which count against it a huge pension deficit and a history of dividend cuts being two of them. But I think the seemingly relentless hunger for bandwidth should present further opportunities for the company. BT appears to be entering a more stable phase financially and yields over 5%, again with dividend growth anticipated.

Lastly, I like a company that has a low but fast-growing dividend BG Group (LSE: BG). It has a far better profile of reserve growth than the super-major oil companies. It may well make an attractive acquisition too. Meantime, it has the right dividend policy to drive long-term returns.