Dividend stocks form the core part of my portfolio. They provide me with a regular source of income, albeit not a guaranteed one, and hopefully some upward movement in the share price.
But the timing of when I buy dividend stocks can make a big difference. And, for me, right now represents a good time to buy. Let’s take a closer look at why!
Fallen dividend stocks
The performance of UK stocks in 2022 was mixed. While resource stocks surged, other parts of the market suffered in the evolving recessionary environment.
So, naturally, I’m looking at the fallen part of the market. And that’s because when share prices fall, dividend yields go up — assuming dividend payments remain constant.
Equally, when share prices go up, dividend yields go down — assuming dividend payments remain constant.
So unless the dividend is at risk, it could pay me to buy now.
Sustainable dividends
When share prices dip and dividend yields get really big, it can be a sign that they’re unsustainable.
For example, Persimmon‘s yield reached 20% as the share price collapsed in late 2022. That’s huge, and it looked like a warning sign.
One way of assessing the sustainability of the yield is the dividend coverage ratio (DCR). This measures the number of times a company can pay its current level of dividends to shareholders.
In 2021, Persimmon’s coverage ratio indicated it only just has enough income to pay its shareholders. In this case, the DCR was just above one. A DCR around or above two would be considered healthy.
So, as the operating environment became less favourable, Persimmon cut its dividends.
Where should I invest?
Persimmon is one of many housebuilders struggling right now. In fact, several stocks in the sector have seen their share prices fall by 50% over the past year.
Housebuilders are probably an extreme example. Conditions have turned against them so unfavourably that margins have come under extreme pressure.
Instead, I’m keeping an eye on housebuilders while looking more closely at other sectors that have faced challenges.
Financial services is one such area. I recently added Direct Line Group to my portfolio and in recent weeks, the share price has gone up 15%. But I’d still buy more.
The firm currently offers a 10% yield, down from nearly 12% when I originally bought it. And the company, which had been caught out by inflation, is now back to writing at target margins.
Obviously, there are still headwinds in the current economic climate, but insurance does have defensive qualities.
It’s also worth noting that Direct Line is down 20% over the year, 31% over two years, and 41% over five years. And looking forward, I see insurance as a solid part of the market. After all, it’s a necessity in many cases.
So right now really could be the optimal time to buy in for this stock.
