How I select dividend stocks for long-term returns

It never seems a bad idea to me to buy dividend stocks. If I pick the right UK shares, they can help me build an additional income stream with limited effort and for a long time. 

After last year’s dividend drought, they have come back thick and fast. There are now plenty of options for an investor to choose from. But not all dividend stocks are made equal, especially not for the long-term investor. So here are four points I consider before buying stocks to earn a passive income. 

#1. Financial health

First, the company in question has to be financially healthy. If it is running up a loss, for instance, I would think twice before buying it for dividends. This is because such dividends will be unsustainable if the company does not earn an income. 

On the other hand, if it has consistently been profitable, I would think there is a higher chance of keeping dividends going. Note that I am happy with profits, and do not always consider profits growth, because the actual number can vary for a variety of one-off reasons, like Covid-19-related expenses this year. If it has a history of being consistently profitable, that is a good indicator for me to start looking deeper into the stock. 

#2. Long-term dividend prospects

It is also essential for me to consider how the company will sustain itself over the long term. Tobacco and big oil, for instance, are established industries that now face an uncertain future. One is harmful to health and the other is harmful to the environment, which is leading to increased investor discontent related to these segments. This explains some of their share price weakness already. 

While both sectors offer good dividends for now, if I wanted to buy and hold dividend stocks for say, the next 20 years, I would research them more closely. 

#3. Past trends

Past trends can often be an indicator of a company’s future actions. So if it has had a consistent policy of paying dividends for a long time, that is unlikely to change in a hurry. Similarly, if a company has just started paying dividends, I have no real reason to believe that it will in the future as well, unless it says so explicitly. And even then, the dividends will depend on its performance and outlook. 

#4. Dividend yield

Last, but certainly not least, is the dividend yield. I think of yield as similar to the interest paid to me on my savings account. Just as I would put my money in a savings account with a higher interest rate, I would also like to buy stocks that offer me a higher yield. Of course, here I have to be careful that I am not looking at just the dividend yield but that the other three aspects also fall in place.