Buying UK dividend shares can produce a relatively attractive passive income. Furthermore, it can lead to capital growth in the long run, with the stock market having a solid track record of producing high single-digit annual returns.
However, buying dividend shares also carries substantial risks. For example, there’s a chance of capital loss, while dividends are never guaranteed to be paid by any company.
While eliminating those risks isn’t possible, focusing on a company’s financial situation, its competitive advantage and past performance can help an investor in reducing potential threats.
1. UK dividend shares with sound financial positions
UK dividend shares may be less likely to reduce or cancel their shareholder payouts if they’ve a solid financial position. For example, a company that has a low level of debt and strong cash flow may be able to maintain dividends more easily than a business that’s highly leveraged.
A stock with sound finances may also be better able to withstand challenging operating conditions that could last for a prolonged period of time.
Assessing a company’s financial position can be achieved through analysing its latest updates. For example, debt levels can be viewed on its balance sheet. Comparing them to equity could provide guidance on its financial situation.
Similarly, cash flow can be compared to profit to gauge the extent to which a company is able to convert profits to cash. This may build a picture of its financial success. And particularly its chances of paying rising dividends.
2. Stocks with competitive advantages
UK dividend shares that enjoy competitive advantages over their peers may also have a more reliable shareholder payout. Clearly, assessing whether a company has a competitive advantage is very subjective. However, it could include factors such as unique products or brand loyalty that have previously allowed for higher margins and more resolute financial performance.
Companies with a competitive advantage may also be able to capitalise on long-term growth opportunities more easily than their peers. For example, they may survive a period of weaker sales performance for the industry to maximise their market position and grab market share.
3. Past dividend performance
Clearly, past performance should never be used as a guide to future dividend payouts. However, UK dividend shares that have a solid track record of shareholder payouts may be more likely to follow suit in future. For example, they may have defensive characteristics.
And that means they’re more likely to be able to pay dividends – even in a period of weaker economic performance. They may also be able to capitalise on a period of long-term economic growth.
Through buying such companies, it may be possible to build a more robust passive income stream. While not without risk, they may offer relatively high potential rewards in the long run.