My ‘secret sauce’ for finding the best dividend stocks, and those I’d buy today

I’ve been applying this method to pick the best dividend stocks for a number of years now. Here’s my strategy, and three stocks I’d buy today.

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I’m always on the lookout for dividend stocks to buy. I use a simple strategy to improve my chances of picking the best dividend stocks for my portfolio. To me, these companies are those with high yields (above the FTSE 100 dividend yield), but that also pay dependable dividends. So, here’s my ‘secret sauce’ for finding these stocks, and those I’d buy today.

Risks to consider first

My main reason for investing in dividend stocks is the potential for passive income. With interest rates so low (a 10-year UK government bond only yields about 1.2% right now), I can generate more income from dividends. It’s a balance of risk and reward. Dividend stocks give me potentially higher reward (greater income). However, there’s more risk involved.

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I essentially own a small slice of a company if I buy the shares. As a business part-owner, I’d be entitled to a small share of the company’s earnings. Businesses aren’t always profitable though. There are a whole host of reasons why, such as increased competition, recessions, or more recently, Covid. Therefore, if the profits of my companies fall, there’s a high chance the dividend will be cut.

This isn’t the same thing with a UK government bond though. I’m almost guaranteed to receive my interest payment from the government, so the risk is lower.

My ‘secret sauce’

To give me a better chance of picking the best dividend stocks, I don’t only look at how high the yield is today. There are two further measures I look for.

#1 Dividend History: how dependable has the company’s dividend been over the past 10 years?

#2 Dividend Growth: is the company expected to grow its dividend next year?

This is what I refer to as my ‘secret sauce’. If I’m satisfied with the answers to these questions, I’m far more likely to buy the shares of the company I’m researching. In my experience, a company that has paid a regular dividend, and is expected to grow it in the following year, makes it an attractive dividend stock.

Best dividend stocks I’d buy today

I’ve been screening for dividend stocks with yields higher than the FTSE 100. The current forward yield on offer is 4%, so I want to aim higher than this. Then I apply my method above to find the best dividend stocks for me.

The first two companies’ stocks I’d buy are Legal & General and Aviva. Both offer yields above 5%, and crucially, have 10-year average yields above 5% too. This shows they’ve been regular dividend payers over the years. Aviva is expected to grow its dividend by 15% next year, and Legal & General by over 4%.

I’d also buy SSE, a utilities company that should offer a dependable dividend income due to the defensive sector it operates in. The forward yield is 5.4% today, and the dividend is expected to grow by almost 4% in 2022. The average 10-year dividend yield has been a highly respectable 6.3% as well.

In summary, dividend investing is not without risk, and is certainly riskier than buying a UK government bond. But if I follow my ‘secret sauce’, I’ve been able to generate dependable dividends over the years.

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Dan Appleby owns shares of Legal & General and Aviva. 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.

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 considered, so you should consider taking independent financial advice.

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