Despite the recent stock market rally, buying UK dividend shares today could deliver decent long-term returns for investors.
The stock market can be a volatile place. Last spring, stocks crashed as the Covid-19 crisis hit the markets. But since the lows, many shares have been roaring back. Although the crisis has damaged some businesses more than others and their stocks remain depressed.
Income from UK dividend shares
But with such big moves up and down in stock prices, it can be difficult for investors to achieve capital gains from shares. And one timeless investment strategy involves focusing on dividend income instead.
Such an approach makes sense. Historically, a big chunk of the long-term gains from shares has arrived via shareholder dividend payments. And stocks with decent and growing dividend yields often offer modest valuations, although that’s not always true.
Sometimes, for example, a high dividend yield can be a warning sign for investors. If share prices have fallen and pushed the yield up, it could be because the underlying business is underperforming. Often in cases like that, a dividend cut may not be far away.
So dividend investing has risks just as any other strategy for buying shares has risks. Indeed, investing in shares always carries uncertainties and gains are never guaranteed. But I’d aim to minimise some of the risks by researching and analysing the businesses underlying the dividend shares that interest me.
For example, I’d want the business to be well established in the niche of the markets it serves. And I’d want to see a consistent multi-year record of trading and financial figures. My ideal investment would have a record of annual rises in revenue, earnings cash flow and shareholder dividends. And I’d look for evidence such performance can continue in the years ahead.
Careful selection
Of course, not all companies with a high dividend yield would make it into a portfolio. One danger area that makes me wary is the high dividend yields we often see in the more cyclical sectors. Trading can be volatile for companies in sectors such as finance, natural resources, retail and others. And a high dividend today could be replaced with zero dividends tomorrow. And that can happen at short notice if earnings plunge as a cycle turns down.
Instead, I’d look for sustainable dividend yields in less-cyclical sectors such as healthcare, utilities, branded fast-moving consumer goods and others. And I’d be sure to diversify my dividend-focused portfolio between several stocks in different sectors.
Finally, I reckon the best way for me to aim to maximise my long-term returns from dividend stocks is by reinvesting the dividends along the way. By doing that I’ll be compounding my investment gains. And I’d hold my investments in a Stocks and Shares ISA to take advantage of the tax relief available.
