Dividend shares are an excellent source of passive income in my Stocks and Shares ISA. Many UK shares offer a dividend payment, but they differ in yield and reliability. Some companies choose not to pay shareholders in the form of dividends as they may prefer to reinvest profits to grow the business. That’s okay. Every company has a different policy.
I own both growth shares and dividend shares in my own portfolio.
Dividend shares – my criteria
When I’m looking for dividend shares there are some criteria that I’d like to fulfil. For instance, I look for companies that offer a dividend yield of over 6%. I also ignore companies where the dividend yield looks too high. For example, a dividend yield of 14% might be unsustainable and there are risks that the payment could be cut. It’s also one reason why I look at the dividend cover. This shows me how well the dividend payments are covered by earnings. If it’s less than one, then there could be risks the current level of dividends is unsustainable.
Another point of comfort is the number of years a company has paid out dividends. I’d view a company as a reliable dividend payer if it has paid out for at least the last five years.
Next, I’d like to see reasonably growing earnings and reasonable forecasts for the upcoming five years. Neither historical figures nor forecasts is a guaranteed predictor of the future, but it does provide another layer of comfort for me.
Which dividend shares?
So which high-yield dividend shares would I buy now? Currently I’m keen on Rio Tinto (LSE:RIO). This FTSE 100 metals and mining giant offers an 8% dividend yield and has a decade-long history of payments. Dividends are well-covered by earnings. And earnings are expected to grow over the coming years. That being said, most of its business is correlated with iron ore prices. There are multiple factors that determine commodity price movements, so Rio’s share price can be somewhat volatile. However, I reckon it’ll provide a hedge against potentially rising inflation. Overall, including share price return and dividend payments, it has returned an annualised 17% over the past five years. I reckon that’s pretty good and would be keen to add it to my ISA.
Building the pot
Next, I’ve got housebuilder Persimmon (LSE:PSN) on my watchlist. Like Rio, it offers a relatively generous dividend of 9%. This may seem high, but Persimmon is highly cash-generative and has a history of operating a shareholder-friendly dividend policy. The dividend is reasonably covered by earnings, and Persimmon offers earnings growth. There is a structural shortage of homes in the UK, and Persimmon is well-placed to supply this growing demand for many years.
That said, interest rates are more likely to rise than fall over the coming years. Potentially that could lower the amount that new home buyers can borrow.
Over the past five years, Persimmon’s total shareholder return has been 13% per year on average. That’s pretty good I reckon. Its share price has drifted slightly lower of the past year, but I reckon that provides an opportunity for me to buy these quality shares at a discount.