As we emerge from the aftermath of the stock market crash, many investors are seeking the share prices most likely to grow in the next 12 months. But not me. I’m trying to identify the best UK dividend stocks to buy.
If I buy a depressed stock that has a good chance of a short-term recovery, I might enjoy a quick one-off profit. I’m not going to sneer at that. But if I can find good dividend stocks going cheap, I can hopefully lock-in better dividend yields for the long term.
If I can achieve that, I’ll get a better return on my investment every single year for as long as I hold the stock.
Take BP (LSE: BP), for example. The oil giant cut its dividend in 2020 by 37%. And the share price crashed. By October 2020, BP shares had slumped by 60% from their pre-crash level. But wind forward to 2021’s first-half results, and things look like they’re turning around. BP raised its interim dividend by 4% from last year’s rebased level.
If the the final dividend increases by 4% too, shareholders will be pocketing around 19.6p per share this year. On the current BP share price, that would provide a yield of better than 6.5%. So if I buy BP shares now, I’ll get that 6.5% per year, every year, on my initial investment (assuming the dividend is maintained, of course, which is never guaranteed).
But if I’d bought at last year’s low point, my effective yield would now be turning into a whopping 10%. Imagine being able to plonk down some cash and get a return of 10% annually from it just a year later, and every year after. Oh, and hopefully some share price gains on top of it as a bonus. Am I kicking myself for not buying BP shares last year? You bet.
But it still might not be too late. If I buy now I can hopefully lock in that 6.5% yield. You know, the one I might otherwise be lamenting this time next year if the share price rises and the yield falls.
Even bigger yield
BP is only an example, and there are other tempting dividends out there that accompany low share prices. British American Tobacco, to pick one, is a dividend stock whose share price has fallen. British American shares have slumped over five years, though the price has held reasonably steady in the past couple of years.
Meanwhile, earnings and dividend progress has pushed the 2021 forecast yield up to 7.5%. The shares are on a low P/E of around nine. And if we should see a share price revival, that could mark another top yield opportunity missed.
Dividends not assured
The risks with this investing approach are twofold. One is that the shares are down for a good reason. And there might be further bad news ahead that could ruin the investment. Both BP and BATS face big challenges. The other is that future dividends are far from guaranteed, and we should be wary when making assumptions about future yields.
These two stocks are not necessarily the ones I’ll buy. But I do think they’re great examples of the strategy I’m pursuing — seeking to lock-in long-term high dividend yields while the underlying shares are cheap.
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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco. 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.