People choose to invest for many different reasons. Many hope to grow capital. Some invest in ethical causes close to their heart. Some even invest in their favourite sports team. A large group, however, invest in dividend stocks to generate a passive income. Put simply, a number of companies pay a dividend to an investor for holding their shares.
The fall in annuity rates over the past decade has made this strategy popular among retirees to supplement pension income. In a steady or growing stock market, investors may look to extract around a 4% yield through reliable dividend stocks such as Royal Dutch Shell, BP, or GlaxoSmithKline.
In 2020, the world has been subjected to the Covid-19 pandemic. Governments and businesses have had to grapple with the impact, often characterised by falling sales and increasing costs. JD Wetherspoon demonstrated the cause and effect of this by recently posting their first loss since 1984. As a result, many companies have less cash available to redistribute to investors, and therefore cut their dividend.
Half of the FTSE 100 constituents have cut or cancelled dividends this year. For income investors this represents a problem, but in such a problem resides an opportunity. Fellow Fool Karl Loomes showed he would pick dividend stocks in the current market earlier this year.
A FTSE 100 candidate
One such dividend stock I would favour is DS Smith (LSE:SMDS). This view is shared by David Barnes who cited the company as an income and growth opportunity. DS Smith has an attribute that is vital in this current climate, and that is resilience. The group has significant exposure to the groceries and consumer goods sector, and these have underpinned revenue while industrial customers have reduced demand.
There are good opportunities for growth as well. An expanding e-commerce sector will require more cardboard boxes, and a long-term cultural shift towards reduction in plastics and a move to sustainable packaging give scope for growth.
Reinstating the dividend
While there is undeniably a cyclical element to DS Smith’s business, I like the fact that they have expanded globally through acquisitions to mitigate this.
Although the group cancelled its interim dividend in April, the most recent update to the market showed management confidence. This was underscored by a promise to return to dividend payments, although no level of payment has yet been given. It is not wise to try to estimate what they may be based on past dividend payments. Crucially though, having survived the initial impact of Covid-19 in a good position, reinstating the dividend should be a sustainable measure. For dividend stocks, sustainability is key to an investing decision.
A secondary upside is the potential for growth in the share price. DS Smith was it hard in April by the market’s reaction to the initial wave of Covid-19 lockdown. The recent announcement of recovering momentum in Europe and North America, combined with strong cost control and cash generation means there is significant recovery potential.
Foolish summary
The Fool ethos of buying and holding quality shares for the long term is never more applicable than for a dividend stock such as DS Smith. Although the share price is down around 25% from its high, I think there is significant recovery potential. This, combined with the return of the dividend, is why I’d consider it a good income investment for my portfolio.
