3 ways to spot the best dividend stocks to buy in July

With the second half of the year just days away, Jonathan Smith looks for the best dividend stocks to buy for July and beyond.

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Half the year is almost over. That’s quite a thought, but rather than resting on my laurels, I want to try and get ahead in H2. As one of my primary investing aims is to make passive income, I want to look for the best dividend stocks to buy next month. As companies’ performances are constantly changing, so do the dividend prospects. So here are a few ways I try and spot which stocks I should be buying.

Check the yield

The traditional way to look for the best dividend stocks to buy is via the dividend yield. This is a ratio that compares the share price to the dividend per share. I can work this out as a percentage and see my annual return. 

For example, if a company pays out a dividend of 5p per share and the share price is 100p, the dividend yield is 5%. So I know that as long as the dividend stays the same, I’ll get that return each year. This can be handy when it comes to trying to compare different dividend stocks.

Therefore, some of the best dividend stocks for me to buy right now will be the ones with a high yield. There’s a note of caution here though. Simply buying the stocks with the highest yield isn’t always the best idea. There are some FTSE 100 stocks with yields above 7% that I think are quite risky. I think we could see the future dividends cut, so wouldn’t invest right now.

I’d look to target dividend stocks with yields above the average, but not the absolute highest.

Good dividend cover needed

A second method I use to spot the best dividend stocks to buy is looking at dividend cover. This looks at the amount of times the dividend paid out can be covered by the profit from the previous year. Ideally, I want to see a ratio above 1, and preferably over 2.

For companies that run their year end through to the end of March, annual results should have been released recently. This means the information is still fresh and allows me to make accurate judgment calls regarding the dividend cover.

One downside of using dividend cover to find the best dividend stocks is the impact of the pandemic. For many, 2020 results will be an anomaly. This means that the dividend cover is likely to be negatively skewed. Lower profits for 2020 will make the dividend cover look weaker, unless the dividend has been cut. So I need to be aware of this when making decisions on where to invest.

Hot sectors with the best dividend stocks

The final thing I’d look at is the industry that the company operates in. This should help to show me how sustainable the dividend is going forward. 

For example, stocks within healthcare and finance have a bright year ahead, in my opinion. So I think that some of the best dividend stocks to buy are in these areas. Even if the yield is lower than at other firms, the fact that the sector could outperform in future is a plus. This should help the dividend yield to actually increase over time.

Overall, even though plenty of stocks pay out a dividend, the above points should help me to end up with the best ones to invest in.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has no position in any share mentioned. 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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