The FTSE 100 is working hard to break through the highs of the year of just above 7,200 points, but there are still stock market bargains to be had. Bargains could be in the form of undervalued stocks that could offer me large share price appreciation. Or they could be dividend shares. A lower share price can boost the dividend yield, allowing me to pick up more income relative to my investment size!
Not all stocks are bargains
The major red flags I need to look out for when trying to find stock market bargains at the moment are companies in trouble. There is a line between a bargain and a stock that no one else wants to buy. If the share price is low, then it could be for a very valid reason.
This can particularly be key with dividend shares. A low share price increases the dividend yield. Yet if I invest without doing my homework, I could get caught out. A struggling company could cut the dividend down the line due to cash flow issues. If my passive income becomes zero and the share price keeps falling, I’d be annoyed with myself.
So how can I prevent this from happening? I can’t rule out the above ever happening, but I can try to reduce the risk somewhat. For example, I can find stocks that I think are bargains, but check for ratios such as the dividend cover. This looks at earnings per share relative to the dividend per share. If the earnings can comfortably cover the dividend, it gives me confidence that this really is a bargain.
Dividend shares I’m noting
For example, I night think that Vodafone looks like a stock market bargain right now. At 122p, it’s down almost 50% over the past five years, in a downward trend. The dividend yield currently sits at 6.29%, well above the FTSE 100 average. So far, so good. However, the dividend cover is worrying.
Dividend cover of 0.8 means that the dividend per share last paid is higher than the last earnings per share figure. Ultimately, this isn’t sustainable, so I’d stay away.
A stock that I would refer to as a bargain right now is Taylor Wimpey. Although the share price is broadly flat over the past five years, it has dividend cover of 1.2. Importantly, this is above the threshold of 1, meaning that earnings cover the dividend. Add into the mix an attractive yield of 4.63%.
Another example is Rio Tinto. I recently wrote about how I like the company more than rival Anglo American, as it has a lower P/E ratio. Another box that gets ticked is the dividend cover at 1.6. Finally, a dividend yield of 9.22% makes it one of the highest in the whole FTSE 100 index.
All of the above dividend shares to have risks associated with buying them. When I’m looking to accumulate stock market bargains, I’d aim to buy a selection in order to reduce my risk to one company in particular. This gives me the best chance to build a sustainable portfolio for the future.