National Grid (LSE: NG) shares paid a dividend last year of 58.52p. On the current share price of £9.44, this means a yield of 6.2%.
So, investors considering a £9,000 stake in the multinational electricity and gas utility giant would make £558 in first-year dividends.
After 10 years on the same average yield this would increase to £5,580. And after 30 years on the same basis it would rise to £16,740.
Crucially though, by reinvesting the dividends back into the stock – known as ‘dividend compounding’ – vastly more could be made.
By doing this on the same 6.2% average yield, £7,704 would be made after 10 years not £5,580. And after 30 years on this basis, £48,537would have been generated in dividends rather than £16,740.
Including the £9,000 stake, the total value of the National Grid holding would be £57,537. This would be paying an annual dividend income of £3,568 by then.
A lower dividend but a higher share price?
A stock’s yield moves in the opposite direction to its share price. Analysts forecast that National Grid’s yield will drop to 5% in its fiscal year 2026 before rising slightly to 5.1% the year after.
That said, a firm’s share price (and dividend) are ultimately driven by its earnings growth. A risk to National Grid’s is the huge state-directed investment in infrastructure expected of it.
However, analysts project that this will increase 16% a year to end-2027. Indeed, its 7 November 2024/25 H1 results saw underlying profit rise 14% year on year to £2.046bn.
This came from higher revenues in its UK and US operations. It is not only the owner-operator of the electricity transmission system in England and Wales. But it also has more than 20m electricity, natural gas, and clean energy customers in New York and Massachusetts.
National Grid now forecasts operating profit growth for fiscal year 2024/2025 of around 10%. And from 2024/25 to 2028/29, it estimates a compound annual growth rate of 6%-8% in its earnings per share.
How much value remains in the shares?
On the price-to-earnings ratio to start with, National Grid trades at 27.1 against a competitor average of 12.5. So, it is overvalued on this measure.
The same is true of its 2.4 price-to-sales ratio compared to an average 0.9 for its peers.
However, on the price-to-book ratio it looks undervalued at 1.3 against a 1.7 average for its competitors. These comprise Engie at 1.2, Iberdrola at 1.8, E.ON at 1.9, and Enel at 2.
I ran a discounted cash flow (DCF) analysis to gain further clarity on its valuation. This shows where a firm’s share price should be, based on future cash flow forecasts.
Using other analysts’ figures and my own the DCF shows the shares are 19% undervalued at £9.44.
So, the fair value for them is technically £11.65, although market unpredictability may push them down or up.
Will I buy the shares?
Therefore, if I were not focused on buying shares yielding 7%+ I would add National Grid shares to my portfolio today and I feel they are worth investors considering.
I think the high earnings growth potential will drive the share price and dividend much higher over time.
This post was originally published on Motley Fool
