I’m not a big fan of dividend stocks when it comes to trying to build wealth. But as a source of passive income, I think they’re hard to beat.
Buying dividend stocks allows investors to own part of a business and receive a share of the profits without having to do any work. And I think now is a great time to be buying dividend shares.
Interest rates
Dividend shares have been selling off steadily since the start of the year. The iShares UK Dividend UCITS ETF has seen its share price decline by around 8.5%.
The main reason is that interest rates have been rising. As a result, investors have been moving away from dividend stocks into other assets, such as cash and bonds.
As an example, take British American Tobacco. At the start of the year, the stock had a share price of 3,342.50p, which implied a dividend yield of 6.5%.
This might have been attractive in January, when a one-year UK government bond came with a 3.1% yield. But with bonds now offering a 5.2% return, a 6.5% dividend yield doesn’t look as compelling.
As a result, the British American Tobacco share price has been falling since the start of the year. A 24% decline means the stock now comes with an eye-catchingly attractive 9% dividend yield.
This has been a general theme among dividend stocks. Shares in Lloyds Banking Group are down 7.5%, National Grid shares are down 4.5%, and Legal & General’s share price has fallen by 14%.
The last time interest rates were this high was more than a decade ago. So I think there’s an unusual opportunity for investors to invest today for durable passive income in the future.
Investing strategies
There are a couple of different approaches investors can take with dividend stocks. The first involves looking for stocks that will perform steadily and generate consistent income over time.
Shares in companies that provide consumer products, such as Unilever, can be good choices for this strategy. The same is true of healthcare companies like GSK.
These types of businesses typically don’t see much shift in demand, whether the economy is doing well or badly. As a result, profits – and dividends – from these companies tend to be fairly consistent.
There is another approach, though. This involves looking for stocks that will get an extra boost in a favourable macroeconomic environment.
These include shares in companies such as Burberry and Rio Tinto. Discretionary firms and mining businesses often see higher profits when the economy is strong and their dividends go up as a result.
When things go less well, though, investors can find these companies lower their dividends as profits slip. But this often causes the share price to fall, which can be an opportunity for savvy investors.
A passive income opportunity
Investing in dividend stocks isn’t for everyone. I think that investors who are looking to build wealth would do better to focus on companies that retain their profits and use them for growth.
The story is different for investors aiming to give their monthly income a boost, though. And I think that the recent rise in interest rates means there’s an unusually good opportunity at the moment.
