Investment View: Vodafone and GSK – my twin choices for an equitable return

Vodafone. Price: 170p. OUR VIEW: Buy
GlaxoSmithKline. PRICE: 1,427.5p OUR VIEW: Buy

Can equity markets remain at their current levels or is there another nasty squall bubbling on the horizon?

Well, if you put 10 professionals in a room together you would almost certainly get 10 different answers.

The main word on everyone's lips at the moment is "uncertainty". Nobody is really sure what nasties might be peeping over the horizon. And equities could easily take a bath if any of those nasties jumps up, just as one did in August last year.

The most obvious shocks are likely to come from Europe, where the next crisis in the sovereign debt of a fringe country (Spain?) looks like it is just waiting to break out. But don't forget the US, which has debt problems of its own, not helped by a bitterly partisan Congress and a presidential election. And don't forget China. On Friday, its GDP growth came in at the low end of where it has been historically. Time to bite those fingernails?

Maybe not just yet. Balanced against that, there have been at least some signs of economic improvement in places, but if things are actually getting better, people don't want to risk saying so just yet. What should sustain share prices at their current levels is monetary policy across Europe and the US. Rock-bottom interest rates mean you get nothing for holding cash. Bond yields are also pitiful, at least on those you might want to hold (eg German bunds, or perhaps gilts).

In other words, if you want any sort of return, equities are just about the only asset class that can provide it. The numbers tell their own story: the FTSE 100 currently yields just under 4 per cent, against a 10-year gilt offering just over 2 per cent.

All the same, against this background a safety-first strategy is no bad thing. Bill Dinning, the head of strategy and economics at Kames Capital, sums it up nicely: "Companies with high dividend yields and good prospects of increasing those dividends are attractive."

Here are two that I like, both of which fit the bill.

First up is Vodafone. The shares have basically been treading water for the past six months. However, they have much to recommend them. Whatever happens to the global economy people are not going to stop using their mobile phones.

Strategically Vodafone has been doing the right things. It has been cutting down on the number of small stakes it has all over the place, sensibly rationalising its portfolio. The dividend from its US joint venture is being shared out among investors. It has been very actively buying back shares in recent weeks. Then there is the impressive, and growing, dividend yield. Vodafone offers a forecast payout of 7.4 per cent for the year to the end of March 2012, 7.6 per cent for the current trading year.

The business is highly cash generative (so the yield isn't under much threat) and ought to be able to start growing earnings per share next year.

This column is unique among investment views in at least taking note of ethical issues, and Vodafone's tax affairs have been attracting a fair amount of comment recently. Let's be clear about this: if the company deserves a kicking for paying a pittance, then so does HM Revenue & Customs for allowing this. I suspect the group will ultimately have to dig into its pockets to keep everyone happy.

That needs to be borne in mind, but Vodafone still trades on a relatively benign forecast multiple of 10.8 times this year's earnings. Unlike the cigarette companies I looked at last week, Vodafone does hold a place in the FTSE4Good index, so it at least meets various corporate and social responsibility standards (take your own view on how good those standards are).

As does GlaxoSmithKline (GSK), the drugs group which is my second safety-first pick. Its yield is not quite as spectacular, forecast at 5.2 per cent for this year and 5.6 per cent next year, but earnings per share growth is better (7 per cent this year followed by 9 per cent). At the same time, its multiple is by no means stretched at 11.6 times forecast 2012 earnings, falling to 10.7 times in 2013.

GSK's product is even more resistant to a fresh downturn than Vodafone's (people don't stop getting sick in a recession, au contraire) and the company looks to be in fair health.

Drugs companies, it is true, aren't finding life easy right now. New treatments are proving hard, and expensive, to develop.

GSK does at least have the resources to gobble up any promising biotech it should want, and is taking advantage of government measures to make research cheaper from a taxation standpoint (if you develop and patent new treatments in the UK you pay tax at just 10 per cent on the earnings).

Again, GSK is a good, safety-first buy whose yield alone should keep investors happy even if share prices generally prove to be choppy.

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