One of the more common questions I hear is “should I invest in dividend stocks?” Dividends are mostly favoured by people who want to create a consistent passive income stream or build their wealth over time.
Today I’d like to discuss several points on dividend investing in easy-to-digest terms.
Many investors like dividend shares
A dividend is a distribution from a business to its shareholders.
Buying a dividend-paying, blue-chip share is often one of the first steps to get started in investing. Any capital gains delivered by the stock are an added bonus on top of the dividend.
When we reinvest dividends, we put the payment back into buying more shares. Income investors know that they can compound their returns through reinvesting dividends.
Not all dividend-paying companies are equally stable and reliable. Therefore investors should perform due diligence. For example, the cash flow statement shows a company’s cash inflows and outflows during an accounting period and acts as an important point of reference.
Ultimately dividends are supported by a company’s free cash flow – cash from operations minus tax, interest expense, capital expenses (capex), and adjusted for working capital requirements.
When a company has positive or growing free cash flows, it could signal to investors that the business is financially robust enough to fund its future payout. Companies would be unable to sustain dividends without sufficient cash flow.
FTSE 100 shares
As one of the highest-yielding markets in the world, the FTSE 100 currently has a generous dividend yield of 4.5%. The FTSE 100 consists of the 100 UK-listed stocks with the biggest market capitalisations.
Most of the shares in the index declare regular dividends. One notable exception is Ocado Group.
In the UK, dividends on ordinary shares are normally paid twice a year. Ashtead, Bunzl, and BT Group are examples of businesses that pay first an interim and then a final dividend.
However, there are also several London-listed securities offering quarterly dividends, such as British American Tobacco, Lloyds Banking Group, and Unilever.
One of the reasons companies may decide to pay dividends quarterly is to send a signal to the market that they have strong balance sheets with positive cash flows throughout the year.
Outside the FTSE 100
If you want to look beyond UK’s largest index, then you may be interested to know that several investment trusts also pay quarterly dividends. Two such trusts are the UK Commercial Property REIT and Schroder Real Estate Investment Trust.
If you are not quite sure where to begin, a low-cost FTSE 100 tracker fund might also be appropriate.
Finally, the FTSE 250 index is home to many companies that have robust dividends.
Special dividends
Over the past two years, with uncertainties around Brexit, the recent general election, and US-China trade wars, the FTSE 100 has been volatile and at times out of favour with many investors. As share prices have gone down, dividend yields have gone up.
Yet another factor that has helped increase UK dividend yields is the growth of special dividends.
If it has been an especially strong year in terms of revenue, a company’s board of directors may decide to share part of the profits with shareholders by declaring a special dividend.
In the past few years, many companies, including Barratt Developments, BHP Group and Next, have been paying out special dividends to appeal to more income-seekers.