Cameron Builds Perfect Climate for U.S. Income Investors

Many Americans don’t realize that the British election on May 7 has opened up some exciting opportunities for U.S. investors.

You see, David Cameron’s victory more or less assures a moderately pro-business Conservative government in the United Kingdom until 2020.

That doesn’t mean all of Britain’s problems are solved – far from it. However, it does suggest that the country is now a safe haven for income investors.

Since Britain also offers dividend levels that are quite juicy in U.S. terms, it’s worth allocating a portion of your portfolio across the pond.

Taking Stock of the British Economy

Following Cameron’s victory, two uncertainties are looming when it comes to the British political scene in the coming years.

First, there’s Britain’s future membership in the European Union to consider.

Cameron will attempt to renegotiate Britain’s deal with the EU and then hold a referendum on membership, which must happen by 2017. He will likely campaign to remain in the EU, and the opposition Labour and Liberal Democrat parties will almost certainly do the same. Thus, it’s quite unlikely that Britain will vote to leave.

Yet, even if it does, the advantages of a “Brexit” should prevent the economy from being damaged – and could even prove beneficial for Britain. For instance, Deutsche Bank has said it will leave London in the event of a Brexit. But the end of British subsidies to the EU would at least balance the cost of departing bankers.

The second uncertainty is Scotland. The Scottish National Party did astonishingly well in the election, winning 56 of 59 Scotland Members of Parliament. And it will want another referendum fairly soon.

Thus by 2020, Scotland may be an independent country. Again, the reduced subsidies from the British exchequer should easily balance any costs to the English economy of Scotland’s departure.

Overall, Britain’s fairly rapid growth should continue. The International Monetary Fund (IMF) expects 2.5% average growth in 2015-16. That may rise somewhat if Cameron’s attempts to restrain public spending are successful.

Since the dollar has been strong against sterling in the past 18 months, the odds favor a mild strengthening of sterling against the dollar going forward.

Solid British Dividend Opportunities

An added benefit to British dividend investments is that sterling dividend income doesn’t suffer withholding tax. Therefore, it’s generally available in full to U.S. investors with tax-free accounts such as IRAs and 401(K)s.

Now, British investors take their dividend payments quite seriously, so there are a number of companies paying dividends while making losses. I don’t recommend pursuing those stocks.

The following, however, do seem worth investigating:

U.K. Income Pick #1: Ladbrokes PLC (LDBKY) runs 2,700 betting and gaming outlets and has 800,000 online customers (online gaming is legal in the U.K.). In 2014, it had earnings per share of 4.4 pence and paid out dividends of 8.9 pence, giving it a P/E ratio of 26x and a dividend yield of 7.3%.

This year, 4Traders expects earnings of 6.5 pence and a dividend of 7.3 pence, giving it a yield of just over 6%. Thus, it’s a high-risk business. But Ladbrokes has a dominant market share and even a 6% dividend is not to be sneezed at.

U.K. Income Pick #2: Those with less stomach for risk may want to consider the British homebuilder Berkeley Group (BKGFY). Berkeley focuses on the urban regeneration and mixed-use markets in London and the Southeast – the central feature of the new government’s plans to increase the housing stock.

Berkeley is trading at 11.9x historic earnings and 11.4x projected 2015 earnings. It currently pays a dividend of 180 pence per share, giving it a yield of 6%. The main vulnerability here is a rise in interest rates, which – in Britain’s overheated housing market – could cause another crash.

U.K. Income Pick #3: GlaxoSmithKline PLC (GSK), one of the world’s leading drug manufacturers, offers a dividend yield of 6.4%. The shares are currently trading at just 7x historic earnings. But, like many drug companies, GSK is affected by patent expiry in the United States. However, the multiple for 2016 is a reasonable 17.4x, and the group’s five-year forecast is for further single-digit revenue growth.

U.K. Income Pick #4: Finally, if you want to buy the U.K. market as a whole, there’s the iShares MSCI United Kingdom ETF (EWU). Its P/E is 18x and it yields 3.5%, based on its expected dividend. (The fund had a yield of 7.1% in 2014 because of the big Vodafone (VOD) payout from selling Verizon Wireless.) The expense ratio is also a tight 0.48%. Wisdom Tree also offers the very new Wisdom Tree United Kingdom Hedged Equity ETF (DXPS), which hedges the sterling exchange risk, but I’m not sure why you’d want to do that – sterling looks a good bet to me against the dollar.

Bottom line: If you’re wondering if U.S. income investors should consider buying British shares, just ask yourself this…

Which situation poses more of a political risk?

A crucial election in 2016 with a strong chance of Hillary Clinton winning… or five years of the sound and mellifluous David Cameron?

The choice should be obvious!

Good investing,

Martin Hutchinson

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Martin Hutchinson