I reckon the best dividend shares are those that offer a compelling amount of passive income but not so much that it’s only a matter of time before it’s reduced.
Fortunately, this preference is backed up by research.
Big isn’t necessarily better
According to a study by Wellington Management, stocks that offered the highest dividends (the top 20%) have beaten the return of the S&P 500 index 67% of the time. However, those that still returned lots of cash to their investors, albeit not quite so much, beat the market 78% of the time.
The thing I particularly like about this finding is that it’s based on data from 92 years (1930-2022). That helps to smooth out any abnormalities in the numbers.
It’s important to note that we’re talking about US stocks here. However, I suspect the key takeaway — that some of the biggest yielders tend to underperform because they can’t sustain those bumper payouts — also applies to the UK.
Here’s one I’m avoiding
Thankfully, our stock market is a rich source of pickings for income hunters. But not every stock catches my eye in a good way.
Debt-laden Vodafone is one example of the latter. Its yield is a monster 11% right now, making it the biggest ‘payer’ in the FTSE 100 by a considerable distance.
The trouble is that it also looks vulnerable to a cut. Ominously, earnings aren’t even expected to cover the total dividend in FY24. Throw in huge ongoing maintenance costs and it’s no surprise CEO Margherita Della Valle is trying to sell off assets.
I like these a lot more
Lloyds Bank seems a better bet. Analysts expect the financial juggernaut to yield 6.7% in 2024. Importantly, profit should cover the cash distribution more than twice.
Power provider National Grid is another good candidate. Its yield is 5.6% and the Grid boasts a record of increasing dividends nearly every year. The cover is admittedly lower here compared to Lloyds. However, the essential nature of what it does means the income stream is far more resilient than at Vodafone.
Of course, there’s no such thing as a ‘perfect’ yield.
Out of interest, I also like self-storage provider Safestore. The FTSE 250 member yields 3.5%. That’s decent rather than spectacular. Like National Grid, it also has a great track record of hiking its cash returns. The payout ratio — the proportion of earnings dished out — is just 23% too. In other words, there’s a lot of room left to grow.
Never nailed on
There’s just one snag.
As much as I think it would be sensible for me to concentrate on seeking solid but not excessive passive income, there’s one truth I can’t afford to ignore: dividends from any company can never be guaranteed.
Go back to 2020 for confirmation of this. As the UK locked down for the first time, lots of seemingly reliable firms stopped returning money to shareholders out of caution.
Most (but not all) of these policies have now been reinstated. But the entire episode did serve as a useful reminder to take nothing for granted.
As long as I do sufficient research and remember a well-worn but accurate saying, I should be able to avoid too many calamities: “If it looks too good to be true, it probably is“.
