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The UK stock market has outperformed other forms of investment for over a century. And dividend-paying stocks are my best bet for passive income.
How can I decide which one to buy?
I’ve looked around to see what the experts think. And there are some common themes. Here is my selection of his best tips.
1: Don’t just look for great returns
Going for the highest returns might not be the best approach. There are reasons why performance is high, and not always good ones.
A business can be cyclical. It could still be a good long-term investment. But it would have been a mistake to buy Rio Tinto in 2021, when he paid more than 10%, and expects to get the same every year.
Often, a company could simply be in trouble. And a weak share price can make the dividend yield look good.
2: check profits
Dividends must be covered by profits. If a company earns 50p per share and pays a dividend of 60p, where does the cash come from?
It often comes from a company’s cash. This could cover a one-year shortfall, but it can’t last forever.
I do not like to disturb Vodafone. Oh, actually, yes I do. Vodafone has been paying large dividends for years, but not covered by its profits.
And in the last five years, the share price has fallen almost 50%. That’s not a victory.
3: Look for a progressive policy
I’m happy with a modest dividend yield today if I see a policy, and long-term history, of progressive increases.
A unique performance can fade over the years. But if dividend increases outpace inflation, that can provide better passive income in the long term.
Experts also say that profits will increase more than inflation. This makes sense, since the dividend can’t continue without it.
It doesn’t have to happen every year, as long as the long-term trend is like this.
4: Monitor the balance
I don’t like companies with large debts. Not everyone agrees, and some companies can achieve this by keeping their profits growing above the cost of their debt.
Still, many experts feel the same as I do. And that makes me nervous when I see great dividend yields but high debt on the books. Did I mention Vodafone?
It only takes an economic crisis to increase the pressure.
5: Consider joint investments
Most financial service providers emphasize the need for diversification. And one way to achieve this is to use pooled investments.
We could look for funds that target long-term dividend growth. And distributing the cash can greatly reduce the damage that could be caused by any company that goes bad.
Investment trusts are my favorite because when I buy the shares I become a part owner. And the fund managers work for me.
Some mutual funds have increased their dividends for more than 50 years in a row.
my take
No stock investment strategy is risk-free. But these expert thoughts make a lot of sense to me.
