UK dividend shares are a very popular pick among Stocks and Shares ISA investors aiming for long-term income.
Returns depend on the dividend yield we can achieve. But what actually is that? It’s the dividend per share divided by the share price. So if a share costs 100p and pays a 5% yield, that’ll be 5p per share per year.
Analysts forecast a 3.2% average dividend yield from the FTSE 100 for the current year — though it varies a bit depending on who we ask.
Index returns
That means if we spread our cash across the whole index, we could aim for £32 per year from each £1,000 we invest in our Stocks and Shares ISA.
We could do that with an index tracker, like the iShares Core FTSE 100 UCITS ETF. It currently has a forecast dividend yield of… oh yes, 3.2%.
At that rate, we’d need to build up £375,000 in an ISA to generate £1,000 a month. But I reckon we can aim to do better.
What you need to know
Before we think about better dividend returns, we need to understand a couple of things. Dividend yields are not guaranteed. The best a company can tell us is what it hopes to pay. And companies facing a squeeze often don’t mention the dividend until they cut it.
Also, when we look for high yields, we often see them concentrated in a few sectors. So while we want good dividends, we also need to make sure we have enough diversification.
Beat the index
The FTSE 100 includes shares that pay low or no dividends. So what if we take the biggest? I calculate a 5.9% average yield from the top 20. With a return like that, we’d need around £204,000 in an ISA to pay a monthly £1,000. And that’s a lot less than £375,000.
The top 20 is a bit heavy on the financials right now. But it shouldn’t be too hard to narrow it down a bit and achieve pretty good diversification.
A stock to start?
As an example, the British American Tobacco (LSE: BATS) forecast dividend yield is a fraction above 5.8%, so very close to that top-20 average.
As well as offering a decent yield, the dividend should also be well covered. Forecasts suggest earnings around 1.4 times the dividend this year. For a company that generates strong cash flow, that seems comfortable to me.
It doesn’t mean the dividend can’t falter. But, other things being equal, good cover can reduce the danger. The company has also raised its dividend every year since the start of the century. That doesn’t make it bomb-proof, but a track record like that gives me more confidence.
Challenge
The main risk is that tobacco is going out of fashion, at least in the developed world. British American is doing well in its move towards non-smoking alternatives, but it’s still a challenge.
Saying that, picking from the best FTSE 100 dividends is my Stocks and Shares ISA strategy. And I rate British American Tobacco as one to consider.
