Dividend shares have the potential to offer an excellent passive income, in my opinion. And there are thousands of dividend shares in the UK. So where do I start?
Finding dividend shares
I could filter by the highest dividend yields in the FTSE 100. However, there are some points to note first. The largest dividend yield might not be the most sustainable. Companies need to be able to sustain dividend payouts from earnings. If earnings decline, dividends could be cut.
One simple method that I use to help work out if a company can afford to pay its dividend is by looking at its dividend cover. This is a measure of dividend safety and tells me how many times the dividend is covered by its earnings.
I reckon a dividend cover of over 1.5x could be viewed as healthy and anything less than 1 clearly means I should be cautious.
I’d also want to find dividend shares that pay out consistently. To achieve a regular passive income I don’t want lots of ups and downs. I’d be more confident in companies that have paid dividends consistently for over 10 years.
Which dividend shares?
So which dividend shares would I pick? My top 3 choices offer dividend yields above 4%, have dividend cover of 1.5+ and have been paying dividends for over 10 years. To provide some diversification, I’ve selected from three different industries.
Currently, my top three dividend shares are Phoenix Group, Imperial Brands and BP.
Phoenix Group specialises in pension and insurance products. It offers a generous dividend yield of 7.6% with dividend cover of 1.58x. Although the past doesn’t predict the future, it has a track record of consistently paying dividends for many years.
Imperial Brands is a consumer defensives company that provides both tobacco and next-generation products. Under a new CEO, it is looking to transform the business to create a more consistent performance. It offers a whopping yield of 9%, dividend cover of over 1.7x and has been paying dividends consistently for decades.
Global energy giant BP offers the smallest dividend yield out of the three. It currently offers 5.3%. But with dividend cover of 2.5x it’s also the most secure, in my opinion. BP also has a strong track record of paying dividends spanning several decades. After a weaker pandemic-related period in 2020, I like that it’s now back on track to grow revenues and earnings.
A tasty passive income
So, my top 3 dividend shares provide an average dividend yield of 7.3% and an average dividend cover of 1.9x. I own many growth shares in my Stocks and Shares ISA for capital growth. But if I wanted to add some value shares for more passive income, I’d be happy with this selection.
That said, I know that companies that pay generous dividends might be compensating for lack of capital growth. Declining industries like tobacco and oil need to be carefully monitored to ensure that earnings and dividend payouts can be sustained. And of course, dividends are never guaranteed, as last year proved.
Yet I think my top three choices are excellent options for passive dividend income now and in the future.