The FTSE 100 has been recovering in recent weeks after tanking in early autumn. And despite several economic challenges, notably in the UK, there is greater optimism about global economic activity as US inflation fell and China relaxed some Covid restrictions.
Today, I’m looking at dividend stocks, which form the core part of my portfolio. These stocks provide me with regular, but not guaranteed, dividend payments. When investing in these stocks, I like to look at three things:
- Possible share price growth
- The dividend yield
- Whether the dividend is safe
Yields
One way to work how much investment income I’m likely to receive is through the dividend yield. The metric is a simple calculation, comparing the current annual dividend versus the current share price. A higher dividend yield is often more sort after. However, a very high dividend yield is normally a sign that it’s unsustainable, or something is wrong.
That’s because the yield is relative to the share price. And when the share price drops, the dividend yield rises. However, if the dividend looks sustainable and the company is doing well, investors will flock to the stock, pushing the price up.
Coverage
The dividend coverage ratio is a metic that measures the number of times a company can pay shareholders its announced dividend using its net income. It is calculated as net profit or loss attributable to ordinary shareholders by total ordinary dividend.
If a company’s total dividend payment is the same as the firm’s net income, then the dividend coverage is one. That’s not a particularly good ratio as the company is only just managing to pay its stated dividend. Generally, although it also depends on things like cash flow, a coverage ratio above two is considered a healthy ratio. A ratio below 1.5 may be a cause for concern.
Safe dividends
BP (LSE:BP) currently offers one of the safest dividends on the index by virtue of its considerable dividend coverage. It doesn’t offer a huge yield, around 3.8%, but that’s largely a reflection of the soaring share price. The hydrocarbons giant is up 35% over the year. BP currently has a trailing 12-month dividend cover of 5.03. That means net income would be enough to pay its stated dividend five times over.
While BP operates in a cyclical industry, there’s evidence we’re entering an era of resource scarcity, characterised by greater competition for things like oil and gas, and higher prices.
My second pick is the National Grid (LSE:NG). I’ve chosen this stock for very different reasons. The dividend yield is a handsome 5% and the coverage is around 1.2-1.5 — the firm has just increased its profit guidance.
That’s clearly not the strongest coverage, but it operates something of a monopoly. It has little competition but is regulated by Ofgem, which implements price controls. This means the dividend is likely to grow steadily, but not quickly. In fact, it hasn’t cut its dividend in 26 years, and it has increased its payment eight times over the past 10 years.
So will I buy them? For me, BP looks a little expensive right now. However, I intend to add National Grid to my portfolio before the end of the year.
