Buying dividend shares to make a passive income has long been a large part of stock investing. After all, the yields available in indexes such as the FTSE 100 have often been higher than the income returns available from other income-producing assets.
Determining the best dividend stocks to buy now is a very subjective task. However, many investors may be searching for a mix of high yields, dividend reliability and the potential for a rise in shareholder payouts.
By focusing on undervalued shares with long-term recovery potential, it may be possible to find such companies at the present time.
Buying undervalued dividend shares
Dividend shares could be undervalued for a wide range of reasons. For example, investors may be underestimating their capacity to overcome present economic woes. As such, provided they have maintained their shareholder payouts in recent months and their dividends are affordable, they may offer investment appeal on a long-term basis.
For example, retailers, resources companies and financial services businesses currently trade on low valuations in many cases. Their performances have generally been negatively impacted by an economic slowdown.
However, their financial positions could be sufficient to maintain, or even grow, their dividends even in a challenging economic period. And, since they trade at low prices in some cases, they may offer relatively high yields compared to other dividend shares.
Identifying dividend growth opportunities
One of the challenges when buying dividend shares is obtaining growth potential at a reasonable price. In other words, companies that are expected to produce improving levels of profitability may have high share prices that compress their dividend yields. This may make them unappealing to income investors.
As such, buying UK shares that have the potential to benefit the most from a recovery could be a sound move. The world economy isn’t guaranteed to grow. Nor is any company guaranteed to pay a rising dividend. But GDP growth is widely forecast to increase as the pandemic reduces in size and scale.
This may provide recovery opportunities for many businesses that have experienced tough operating conditions. This may lead them to afford a larger shareholder payout that could increase their appeal versus other dividend shares.
Building a diverse portfolio
There are always risks in buying dividend shares to make a passive income. As such, it’s imperative to diversify among a broad range of businesses instead of relying on a small number of companies for a passive income.
Through focusing on undervalued stocks and sectors that could benefit the most from a likely economic recovery, it may be possible to obtain a high and growing passive income.
Many companies remain unpopular among investors right now. So, there could be opportunities to capitalise on high, affordable yields across the FTSE 100 and FTSE 250.