5 tips to help you choose dividend-paying stocks for income
Dividend stocks are extremely popular among investors due to their attractive combination of growth and income. However, not all dividend paying stocks are good investments. Here are some tips on how to choose the right stocks for dividend income.
What are dividend paying stocks?
Basically, when a business is making a profit from its business, it can use the money in a variety of ways. One of those ways is to pay shareholders. That part of a company’s profits that goes to shareholders is known as a dividend.
Dividend investing is investing in stocks that pay dividends consistently.
The exact amount you receive as a dividend is proportional to the number of shares you own in the company. These are usually expressed in terms of the pence per share.
How do I choose the right dividend-paying stocks for my portfolio?
Here are five tips from Dan Lane, Senior Analyst at Free exchange, which investors should keep in mind when it comes to choosing dividends to generate income from the stock market.
1. Look for high yield (not the highest yield)
The dividend yield is essentially the payment of the annual dividend of a share to shareholders expressed as a percentage of the current price of the share.
Lane believes that the highest dividend yields aren’t always the best. High yields (above around 7%) may indicate problems elsewhere.
For example, if the price of a company’s stock falls while the dividend remains constant, the dividend yield increases. But while a high dividend yield can be an exciting prospect, it can also indicate that the company cares more about shareholders than funding its operations and growth.
Lane recommends looking for dividends with a yield between 4 and 7%.
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2. The best dividend-paying stocks are those that pay
According to Lane, a company’s ability to pay a dividend matters more than the dividend itself.
He recommends looking at the financial metric known as dividend coverage, which basically measures the number of times a company can pay dividends to its shareholders. Dividend coverage will, for example, be expressed by holding two or three times the level necessary to achieve the next dividend.
Cash levels on the balance sheet can also help determine whether a business can continue to pay dividends rather than offering a large dividend payout while the business collapses.
3. Join the Dividend Heroes and Aristocrats
Investors should be on the lookout for companies with a strong dividend track record, as this demonstrates the company’s commitment to paying dividends.
A good place to start is with dividend aristocrats, which are companies that have consistently paid or increased their dividends over time (10 years for UK companies and 25 years for US companies).
Another option is the Dividend Heroes. These are trusts that have steadily increased their dividends for at least 20 years and pride themselves on keeping this record intact.
Trusts are particularly attractive because of their ability to reserve up to 15% of their income during good times so that payments can be completed and kept relatively constant during bad times. Lane believes this is a huge benefit for those who need a stable income, such as retirees.
According to Lane, distributing your sources of income across industries, countries, and different business sizes helps reduce the impact that specific events can have on your dividend income.
Investment trusts and ETFs are a great place to start to give you instant diversification.
However, even if you own a lot of dividend funds, check what they actually contain. You may have a few funds in your portfolio and believe that you are well diversified when in fact you have a few similar funds with the same combination of companies.
5. Plan your payments accordingly
If you intend to generate regular income from dividends, make sure your portfolio is aware of your goal. Remember that dividend-paying stocks have different payout periods. Different companies pay monthly, quarterly, semi-annually or annually.
If you want to maintain a constant stream of income, you should do some research to help you build a portfolio that will pay you back throughout the year.
If you are considering investing in good dividend paying stocks, be sure to hire a solid and reputable broker whose values match your investment goals and strategies.
To help you narrow down your options, we’ve compiled a list of some of the UK’s leading online sharing account providers.
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