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Picking dividend shares when dividends are collapsing

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This does not seem like the right time for income investing. Companies everywhere are reducing or halting their dividend payments. Personally, some of my best income investments have stopped their dividends in the past few months. I dread the results of those that still do pay, waiting for another penny to drop.

It might seem strange then, that I actually think we have an opportunity. In this environment, we may be poised to set ourselves up with even greater income generating stocks. Here’s how…

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Troubled times

Firstly, it is worth pointing out that, of course, some UK companies are still paying dividends. But even with this as the case, the current environment seems to mean that these payments are far from certain. At the same time, income investors may be flocking to the few ‘golden geese’ that keep paying, likely inflating the share prices.

These fears and troubles can be to our benefit, however. As income investors, I see two key opportunities for us at the moment.

Low prices, high yields

The first benefit is that share prices generally are under pressure. Covid-19 concerns, low oil prices, and political uncertainty are weighing on previously strong shares. Though some of these worries are valid, not all are. Nor are they valid if we look to the longer term.

Naturally this offers the potential for capital gains. But even better for dividend investors, this offers us potential to effectively lock in higher yields. Even if those yields don’t currently exist.

When dividends come back, they will still be paid on a pence-per-share basis. This means the current yields may be 0%, but this will jump right up when these firms start paying out again.

No dividends now or no dividends forever?

I have always argued that dividends should not be paid out blindly. In times of trouble particularly, companies may be better off reinvesting income rather than paying it out to shareholders. These are just such times.

Ironically, the companies that cut dividends may be prime targets to invest in. It should be obvious, but those companies that have always paid out dividends consistently are likely to do so again – someday. As I said, it is a sensible decision in these uncertain times to cut dividends. But times will change.

A Covid-19 vaccine will be found. The world will go back to normal. When it does, the big income shares of the past will become big income shares again. As a guide for where this will occur, one can simply look back at the dividend history growth of the FTSE 100 major players.

My advice then, is to look at solid FTSE 100 companies. Companies with strong brands and a good history. Look for firms that were paying dividend yields in the 4%–5% range before they cut them, and look for a history of dividend growth above inflation.

Buy those shares while they are low, then sit back and wait for things to get back to normal.

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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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