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My 5 tips for picking UK dividend stocks in this Covid-19 crisis

Many UK dividend stocks have disappointed income-hungry investors this year. Shareholders have seen an unwelcome rash of cancelled, suspended or reduced payouts. This is because most companies are desperate to hang on to cash. The reason, of course, is the huge economic distress and uncertainty caused by the coronavirus pandemic.

With oil giant Shell having cut its dividend for the first time since World War II, it’s tempting to wonder if any company’s payout can be relied on. However, I think there remains plenty of potential in the market for income investors. Selectivity is required, I’d suggest. Here are my five tips for improving your chances of picking UK dividend stocks with sustainable payouts.

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Reset your yield expectation on UK dividend stocks

We’ve seen historically unprecedented low interest rates and massive quantitative easing over the past decade. With so much ‘cheap money’ floating around, many companies were able to maintain otherwise unsustainably extravagant dividends by borrowing. The yield of the UK’s FTSE 100 reached a level relative to yields on 10-year British government bonds unheard of in 120 years. My first tip for picking UK dividend stocks is to take the yields of recent years as a historical anomaly. This means resetting your general yield expectation to a lower level.

Exceptions to the rule? Are you sure?

Many of the highest yields on UK dividend stocks have already disappeared. However, some remain. As ever, this means the market is deeply sceptical about their ability to maintain their payouts at the prevailing levels. Unless you’re very confident these super-high yielders have special qualities that make their dividends sustainable, I’d avoid them.

Assume conditional largesse from lenders

My third tip for picking UK dividend stocks also falls into the avoid category. I’d steer clear of any company that hasn’t yet suspended its payout, but is in negotiations with its lenders for higher borrowings and covenant waivers, and/or is looking to access government-backed loans. I’d say it’s prudent to assume any largesse by lenders will be conditional on the suspension of the dividend.

UK dividend stocks I’d consider

Following my avoid tips leaves a still-reasonable-sized pool of UK dividend stocks in the FTSE 100 that have maintained their payouts. Their average yields may be lower than the minimum you demanded in the recent past, but this goes back to my first tip to reset your yield expectation lower. As well as these companies that have maintained their payouts, I’d suggest it’s also worth considering those that have rebased their dividends in response to the Covid-19 crisis, and have a policy of progressive growth from the rebased level.

Look beyond the FTSE 100

Finally, my fifth tip is to consider UK dividend stocks outside the FTSE 100. The blue-chip index is the traditional hunting ground for income-seeking investors, but there are a fair number of companies in the second tier FTSE 250 index (and even some small-caps) well worth considering. I’d say the best of these operate in resilient industries, with business models that are well-equipped (in some cases designed) to deliver reliable dividends for their shareholders.

Hopefully, my five tips will help improve your chances of picking UK dividend stocks with sustainable payouts. There are still plenty around!

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.