Forget the cash ISA! I’d pick up the Centrica share price’s 8% yield today

Hand holding pound notes

With cash ISAs offering an income return of around 1.5% per year at best, they’re set to reduce spending power for individuals using them over the long run. Inflation currently stands at around 2.1%, which means that every £1 invested in a cash ISA is failing to offer a real-terms return.

At the same time, there are a number of stocks currently offering high yields. Among them is FTSE 100-member Centrica (LSE: CNA), which has a yield of over 8% after a disappointing period for its share price. With the potential for an improving business model, though, it could be worth buying for the long term.

High valuation

Of course, not all income stocks may be worth buying at the present time. Reporting on Monday was self-storage company Lok’nStore (LSE: LOK), which appears to be overvalued given its financial outlook. It trades on a price-to-earnings (P/E) ratio of 35, despite being forecast to post an earnings rise of 5% in the current financial year. It has a dividend yield of around 2.8% which is only just covered by net profit. As such, it appears to lack a margin of safety, as well as significant dividend growth potential.

Trading in the first half of its financial year has been strong, with revenue rising by 7.7%. Its self-storage unit occupancy was up 8%, while price-per-let square foot increased by 1.4% compared to the same date a year ago. As such, its business appears to be performing relatively well, and further developments to its strategy could enhance this further. But with Lok’nStore having such a high valuation, it appears to be a stock to avoid at the present time.

Income potential

Meanwhile, Centrica’s P/E ratio of 11 indicates it offers a significant margin of safety. Furthermore, a dividend yield of 8.4% in the current year is almost six times the return which is available on a cash ISA. Although dividends are due to be covered 1.1 times by profit this year, such a high dividend yield is likely to mean the income return on offer is significantly greater than many of its FTSE 100 peers able to grow dividends at a fast pace.

Of course, Centrica has faced a challenging period. It’s found the delivery of a new strategy to be somewhat difficult, with its financial performance weak in recent years. However, with it expected to become increasingly efficient as it delivers a variety of cost savings, its financial performance could improve over the medium term.

Since Centrica faces regulatory and political risks at the present time, its shares may lack the defensive appeal which the utility sector has offered in recent years. However, with what seems to be a low valuation and impressive income prospects, it could deliver a higher long-term return than a cash ISA.

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Peter Stephens owns shares of Centrica. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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