The stock market crash may have caused some investors to avoid UK dividend shares when seeking to make a passive income. After all, the FTSE 100 continues to trade over 20% down on its 2020 starting price and the prospects for many of its members are uncertain.
However, with high yields on offer across the FTSE 350 and other assets such as cash and bonds offering low returns, UK dividend shares may offer relatively attractive long-term income prospects.
By purchasing companies with solid financial positions, affordable dividends and growth potential, an investor could build a solid income portfolio.
Passive income affordability
Perhaps the first priority for any investor seeking to make a passive income is dividend affordability. Many stocks have high yields after the market crash. However, not all of them may be able to afford them given the challenging economic outlook and difficult operating conditions that may be ahead.
As such, it is important for any investor to consider a company’s financial standing before buying it. For example, a business with low debt levels and an efficient business model may be less likely to cut dividends in response to difficult operating conditions. Similarly, companies with defensive characteristics may be more able to maintain dividend payouts even while the economic outlook remains challenging.
Furthermore, passive income investors may wish to consider how much headroom a company has when making dividend payouts. In other words, how many times net profit covered dividend payments. A figure of more than one suggests there is a margin of safety so that dividends have a higher chance of being maintained even if profitability comes under pressure.
Dividend growth potential
As well as making a passive income today, many investors will seek dividend growth over the long run. A company that offers a high dividend growth rate but a modest yield today may become significantly more attractive over the long run than a high-yielding stock with minimal dividend growth prospects. As such, dividend growth may be just as important as obtaining a high yield today.
Clearly, a company’s dividend growth rate is largely based on future profitability. This is highly subjective, and difficult to predict at the present time. However, some companies may have business models that are more suited to rapidly-changing consumer tastes. Similarly, some industries may benefit from evolving consumer demands over the coming years. They might include areas such as online retail companies and healthcare businesses, for example.
Equally, companies that pay out a small proportion of their profit as dividends could offer passive income growth potential. They may decide to increase their dividend payout ratio over time. This could make them more attractive income opportunities for investors who are seeking to make a growing income from their capital in the coming years.
