Why I look for more than just a high yield when buying UK dividend shares
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The idea of buying UK dividend shares is often to obtain the highest yields and the largest passive income available. While they may be important, it’s not the only consideration that may be worth focusing on when seeking to build an income portfolio.
Factors such as the reliability of a company’s dividend, its potential to grow and its investment plans could all have a significant impact on its capacity to provide a worthwhile passive income. By focusing on those areas, it may be possible to build a more resilient income portfolio in the long run.
The reliability of UK dividend shares
Clearly, no UK dividend shares are 100% reliable when it comes to earning a passive income. They come with significant risks that can mean no dividends are paid in future, or that capital returns are negative.
However, the risk of experiencing such situations can be reduced by focusing on the reliability of a company’s dividend. For example, assessing a company’s business model may provide guidance on how robust its earnings may prove to be in future.
A company that operates in the utility or tobacco sector may be less likely to experience falling sales or profitability in an economic crisis versus a media or retail business. As such, while no company is ever immune from economic risks, some companies may be less impacted by them than others.
Furthermore, UK dividend shares with financial positions that are sound could be less likely to reduce dividends in the coming years. Strong balance sheets and high cash conversion ratios may not be as exciting to investors as growth plans. But they could prove to be very important when it comes to making a high passive income return in the long term.
Dividend growth opportunities related to investment plans
High yields may also be less important than they seem when investing in UK dividend shares because of the importance of a growing passive income. A high yield may be attractive today, but if it doesn’t grow by at least as much as inflation over the long run then it could equate to a loss of spending power. As such, it is important to obtain a growing income from a portfolio of dividend shares.
Achieving this goal can be difficult because dividend growth forecasts may prove to be unreliable. However, by assessing how a company plans to apportion its earnings, in terms of reinvestment or paying out to shareholders, it may be possible to ascertain the likelihood of a growing dividend.
Companies that have a mature position in their industries may be more likely to pay out profit to shareholders in the form of a dividend. This could make high-yielding, established companies more attractive on a relative basis.
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.