The Motley Fool

What to look for in dividend shares

In times of volatility and fear in the stock market, it is natural for investors to look for growth potential and bargains to invest in. However another strategy that can take advantage of low prices is looking for great dividend shares.

As dividends are paid out in pence per share, the dividend yield measurement we use as a benchmark is dependent on the share price itself. If a company is maintaining its dividend while its share price goes down, you get a higher percentage return on your investment.

Claim your FREE copy of The Motley Fool’s Bear Market Survival Guide.

Global stock markets may be reeling from the coronavirus, but you don’t have to face this down market alone. Help yourself to a FREE copy of The Motley Fool’s Bear Market Survival Guide and discover the five steps you can take right now to try and bolster your portfolio… including how you can aim to turn today’s market uncertainty to your advantage. Click here to claim your FREE copy now!

Long-term vs. short-term troubles

A key caveat with this strategy is that companies sometimes maintain or even increase dividends beyond levels they should. This is usually to hold onto or attract investors, when more fundamental aspects of their finances are perhaps weak.

However in situations like we are currently facing, it is often fear driving prices rather than genuine risks. This could be a chance to pick up strong dividend shares at a relatively cheap price, and thus gain a higher yield.

Of course this isn’t to say all stocks that are currently falling have no real concerns. Airlines, for example, are likely to be fundamentally weakened for a long time to come. Meanwhile other industries, such as oil, are a mix of the two. Fear combined with oversupply and lower demand, will be likely to hit some oil stocks more than others over the long run.

What to look for in a dividend share

Though there are always some fundamental things to look for in a dividend share, some of these are more relevant than others at the moment. First among these are measures of safety.

Generally investing in dividend shares is aimed at income, rather than capital gains. This means we don’t necessarily need to buy a stock at its lowest price. Nor do we need to focus all our resources in a small number of shares to maximise gains.

This means one key goal of buying dividend shares right now should be to diversify your investments. We should be avoiding the more risky industries at the moment. Though many firms will be suspending dividends, there are still a number of potential dividend shares to consider.

You can also achieve this by putting money into an investment trust, which themselves hold a diverse portfolio of dividend shares.

Another good rule of thumb is to invest in big, well-established companies with strong brands. A long history of consistent dividend payouts is also a good sign. This means focusing on blue-chip stocks in the FTSE 100, and looking at their dividend payout histories.

As for the yield itself, things get a little harder. My general rule is for dividend shares yielding between 3% and 6%. The current situation changes both sides of this for me, however. At the lower end, a sensible dividend reduction is a fair move, especially if i expect it to go up again next year.

On the other side, anything above 6% used to flag up warning signs for me. With fear driving price decreases, however, these kind of numbers are now an opportunity.

There’s a ‘double agent’ hiding in the FTSE… we recommend you buy it!

Don’t miss our special stock presentation.

It contains details of a UK-listed company our Motley Fool UK analysts are extremely enthusiastic about.

They think it’s offering an incredible opportunity to grow your wealth over the long term – at its current price – regardless of what happens in the wider market.

That’s why they’re referring to it as the FTSE’s ‘double agent’.

Because they believe it’s working both with the market… And against it.

To find out why we think you should add it to your portfolio today…

Click here to read our presentation.

Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.