For many new investors, dividend shares have obvious appeal. They offer an income return which is usually far higher than those available from cash savings in a bank account, while also having the potential to deliver capital growth. And with dividend stocks historically being seen as relatively defensive and lower risk in many cases, they're likely to appeal to less experienced investors.
However, there is much more to dividend investing than a high yield. Here's how you could find the best dividend shares for your portfolio.
While a high dividend yield may appeal in the short run, buying shares which offer sustainable dividends could be a better move. They may not offer the highest income return this year, or next, but they could provide greater consistency when it comes to future payments.
For example, at the present time a number of resources shares offer high yields. In many cases they're well above the FTSE 100's near-4% level. However, even though they've been able to reduce costs and strengthen their balance sheets, ultimately their future capacity to pay dividends is closely linked to commodity prices. Although their prices may have been on uptrends in recent months, there's no guarantee that they will continue this upward movement.
Therefore, buying shares in industries which offer greater stability in their earnings profile could be a good move. Examples include tobacco, utilities and consumer goods, all of which have stocks within them that offer impressive dividend yields at the present time.
Of course, dividend sustainability needs to be balanced with dividend growth potential. With inflation at 3% following the weakening of sterling since the EU referendum, even a high dividend yield could fall in value in real terms over the medium term. This may make it far less appealing and could lead to a lack of demand for the stock in question from other investors.
As such, ensuring that dividend stocks are able to offer inflation-beating levels of dividend growth could be crucial for income investors. Some industries may offer better prospects than others in this regard. More mature companies operating in stable industries may be able to pay out a higher proportion of earnings as a dividend over time. In contrast, younger companies operating in faster-growing sectors may need to retain a significant proportion of capital each year for reinvestment.
While a high headline yield is attractive to all income investors, searching for companies that offer a significant chance of making future payments at a higher level than today could be key to success in dividend investing. Even though the FTSE 100 has risen significantly in recent years and share prices are generally higher, there are still a number of opportunities on offer to buy large-cap dividend stocks with bright long-term futures.
5 top dividend stocks?
With the above in mind, the analysts at The Motley Fool have written a free and without obligation guide called Five Shares You Can Retire On.
The five companies in question offer stunning dividend yields, have fantastic long-term potential, and trade at very appealing valuations. They could deliver high income returns for your portfolio in the long run.
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