Dividend yields have surged across the London Stock Exchange as market volatility has picked up. In a way this has made it more perilous for investors by supercharging the number of dividend traps out there.
A cheap stock — say one that trades on a low PE ratio — which also carries a high dividend yield often reflects market expectations that dividend forecasts will miss the mark. Investors that are helplessly drawn to big yields are in danger of getting burnt in this environment.
Things are particularly dangerous for investors today as the global economy teeters towards recession. Profits and dividend forecasts are looking increasingly fragile for many UK shares right now.
Key things to consider
There are a number of factors investors can consider when looking for dividend stocks to buy today, however. These include:
- How economically sensitive a share is. Businesses which carry out defensive operations will be more resilient than most. Stocks like this include utilities, defence firms and telecoms providers.
- What dividend coverage looks like. It is said a share whose estimated dividend is covered 2 times or above by anticipated earnings has a strong chance of meeting the dividend forecast.
- The strength of the balance sheet. Considering items like debt-to-equity and free cash flow is essential when profits look increasingly under threat. A robust balance sheet can enable a company to navigate temporary earnings trouble and pay a healthy dividend.
Buying shares for passive income
There’s one final critical thing to think about when seeking the best income stocks to buy. Is a share likely to continue paying big dividends beyond the short term?
Investing in UK shares is a popular way that people try to make a passive income. And buying stocks that should pay large and growing dividends over the long term is critical to achieving a healthy income.
A dividend stock with 6% yields
Telecoms stock Vodafone Group (LSE: VOD) is one such dividend share on my radar today. It is subject to strong competitive pressures, sure. But, fortunately, it operates in an industry which is resilient, even during economic downturns.
This gives it the confidence and the means to pay big dividends whatever the weather. And it’s why City analysts expect the FTSE 100 firm to grow the annual payout this year, resulting in a 6% dividend yield.
On the downside, dividend coverage at Vodafone sits at just 1.3 times. But, in my opinion, this is more than offset by the company’s exceptional cash generation.
In fact in May, the business upgraded its adjusted free cash flow forecasts for this year (to €5.3bn) on account of its exceptional cash flows in the previous year.
I think Vodafone is a great passive income stock to buy for the long haul. I expect it to deliver robust profit and dividend growth as global telecoms demand soars and use of its mobile money platform in Africa balloons. And that 6% forward dividend yield for this year makes it a particularly brilliant buy right now.