Dividends hit record high! How to generate passive income from stocks and shares

Global dividends surged by 15% to a record $1.5 trillion (£1.2 trillion) in 2021, according to Janus Henderson. In addition, the investment management company reported that “one-off special dividends also soared to a new record.” With the cost of living squeeze, passive income from investments can help to supplement your household income.

Here, I look at the highest-paying dividend sectors and companies. I also explore the basics of generating an income stream from investments.

[top_pitch]

Who were the top dividend payers in 2021?

Janus Henderson reports that UK headline dividends rose by 44% in 2021, the second-highest globally (behind Australia). The mining sector was the key growth driver, increasing regular dividends as well as paying record special dividends.

According to Janus Henderson, these were the five highest dividend payers in 2021:

Looking ahead to 2022, Janus Henderson believes that “banking and recovering oil dividends will be the main engine of 2022 dividend growth in the UK.”

What do you need to know about dividends?

1. How can your shares generate an income?

There are two ways of generating an income from your shares:

• Selling a proportion of your shares.
• Investing in companies that pay dividends. This protects the capital part of your investment, which can be left to grow.

2. How can you measure dividend income?

The key measure is the dividend yield. This is the dividend per share divided by the current price per share. It’s similar to the interest rate you receive from a savings account.

A higher dividend yield means you receive a higher percentage return from your initial outlay.

3. Are dividends a reliable source of income?

The answer is: somewhat. A company’s dividend policy is seen as an important signal to investors. A dividend cut tends to be received poorly as it may suggest future earnings issues.

That said, dividend cuts can be acceptable in the face of extreme events such as the pandemic. Simon Adler, fund manager of Schroders Equity Value, comments that it is wise for companies “to cut their dividend if they feel it is unsustainable or the money is better spent elsewhere.”

4. Which types of companies pay dividends?

For the most part, these companies operate in more ‘defensive’ sectors such as pharmaceuticals and consumer staples with stable demand. As a result, they tend to be less impacted by recession than ‘growth’ stocks. This enables them to maintain a consistent dividend payout.

On a similar note, high-growth companies often pay little to no dividends, preferring to reinvest surplus funds into future growth. In this case, shareholders’ returns are mostly from any potential increase in share price.

Who are the highest dividend-payers in the UK?

According to a report by IG, these are the 10 dividend stocks with the highest yields in the UK, based on a number of factors such as future growth prospects and market capitalisation:

Given the current market volatility and high inflation, there has been a general move out of high-growth stocks into more defensive options. Increasing demand can drive up share prices and therefore reduce dividend yields.

But caution should also be taken over a high dividend yield. Katya Stead from IG notes that “a very high dividend yield, usually above 7%, can be a red flag for investors.” This is often due to a sudden fall in share price, driving up the dividend yield.

She points to the importance of dividend cover (net profits divided by the dividend). A dividend cover below 1 is a warning sign as profits don’t cover dividends. This signals a likely cut in future dividends.

How do shareholders receive dividends?

You’ll receive a dividend payment for each share you hold. Dividends are usually paid two to four times a year. In addition, companies sometimes pay one-off ‘special’ dividends to return cash to shareholders.

1. Key dates to watch out for

There are a couple of key dates to bear in mind for dividend payouts:

• Record date: shareholders on the ‘record’ are eligible to receive the upcoming dividend on this date (i.e. this is the cut-off date).
• Ex-dividend date (one business day after the record date): the upcoming dividend is not payable to any shareholder buying shares on or after this date.

[middle_pitch]

2. Receiving dividend payouts

Depending on your broker, you can choose to receive your dividends in cash, or automatically re-invest them (by using them to buy more shares).

It’s worth checking the fees as some brokers charge for reinvesting dividends. Our experts have compiled a list of our top-rated share dealing accounts, including a comparison of fees charged.