Part of my Stocks and Shares ISA is made up of a selection of dividend shares. I don’t expect their share prices to rise in leaps and bounds, but I do like the regular passive income they provide.
The FTSE 100 currently offers an average dividend yield of 3.4%. Although this changes, it has tended to hover around 3.4%-4.5% over the past decade. That said, I prefer to pick individual shares that offer higher-than-average yields. For instance, 11 of the FTSE 100 shares currently pay a dividend yield of over 6%. This is the group that I’d like to target.
There are several factors I’d consider when making my selection. Contrary to to what some might think, I wouldn’t necessarily pick the highest-yielding shares. Although a share could yield over 10%, I’d say it’s likely to be temporary as it means the market is ‘marking down’ the share, perhaps expecting a dividend cut or other bad news. A sustainable dividend is just as important as the percentage yield, in my opinion.
A sustainable dividend is one that a company can afford to consistently pay from its earnings. One measure that I use to determine affordability is its dividend cover. This is the number of times a company can pay dividends from its earnings. Generally, I’d say dividend cover of over 1.5 provides a decent cushion of safety.
Next, I’d look at how many consecutive years a company has paid dividends. A company that has paid them every year over the past decade provides me with more comfort than one that has started paying a dividend more recently or has a long-but-patchy record on this front.
Which dividend shares?
So considering those factors, which dividend shares would I pick? Currently, I’d be looking at Polymetal International, Legal & General, and Phoenix Group. Each offers a dividend yield of around 7%. Also, they all have a dividend cover ratio of over 1.5. Finally, all three have a track record of consistent dividend payments spanning over 10 years.
All three are from the FTSE 100 index and meet my criteria for ‘dirt-cheap’ dividend shares. Such shares that offer above-average dividend yields aren’t often bought for share-price growth. That said, over five years my top three picks actually returned an annualised 4.9% excluding dividends. I reckon that’s pretty good.
Factors to consider
There are some things I have to bear in mind, however. Past returns don’t predict the future. Dividends can be cut for a number of reasons. Businesses can decline and a fall in earnings can have a significant impact on dividend payments.
Even companies with long track records can have their business models disrupted. It’s still important that I keep an eye on what the companies are doing and if they’re keeping up with the competition.
Overall, I own a mixture of growth shares and dividend shares. My growth shares tend to grow faster, but are more volatile. Whereas my dividend shares are in more mature businesses, with less volatile share prices. I rather like the balance of owning both.
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Harshil Patel has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares 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.