Looking at the markets over the past day or so, one could be forgiven for thinking Covid is all over. It’s not. The Pfizer news is positive, but the future is still uncertain. What’s more, the hangover and troubles of lockdowns this year will still be impacting companies’ numbers in 2021. With that in mind, here are my three rules for picking dividend shares with so much uncertainty around.
Go big or go home
In today’s market, if I’m investing for dividends I want as little risk to the downside for the shares as possible. Though it far from guarantees this, the safest bet is to go for larger, blue-chip companies, I feel. I look at the FTSE 100, and only consider those firms with strong brands. My rule number one: “Pick a company your Gran has heard of.”
Once a dividend share, always a dividend share
Many companies have cut or postponed their dividends during the Covid troubles. I almost always think this is a good strategy. Reinvesting cash back into a firm helps secure its future in troubled times. Usually much more so than short-term rewards for those who hold its shares.
Firstly, there are still plenty of FTSE 100 companies paying out. Aside from this, those companies with a history of paying good dividends are much more likely to reinstate them when they can. Even if a dividend is low or postponed today, I look for shares that have paid out good money in the past.
I want consistent payouts, and preferably decent year-on-year dividend growth. So my rule number two is: “Find companies that have paid strong, consistent dividends over the past five years. Consider these shares even if the payout is not quite as good today.”
Show me the money
Which brings me to my last rule. When looking at dividend shares, the yield is usually my primary concern. In today’s market this is somewhat different. As I said above, I would consider a share with a lower yield now, as long as its past dividends matched rule number three: “Look for yields in the Goldilocks zone.”
As the name suggests, the Goldilocks zone is not too hot, and not too cold. It’s just right. For me, this is usually in the 4%-6% range.
Let me explain. Firstly, we can do better than sub-4% as income investors. There are shares out there paying that level or higher.
On the other hand, while we obviously want to achieve the highest yield possible, a company can be paying out too much. A company that’s trying to entice investors by offering a very high yield probably needs to do so because of other weaknesses.
But one major caveat I have here, is that the dividend yield is also determined by the share price. There are many times when shares go lower than they should (fear drives selling rather than fundamentals). In these cases a yield can go higher than the Goldilocks zone but be a good investment. I’d lock that yield in quickly!
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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.
Motley Fool UK 2020