Dividend stocks are an excellent way to earn passive income, in my opinion. But given the stock market turbulence right now I’m look for the safest variety.
But what makes one income stock safer than another? There is a list of criteria that I’d follow to find the best dividend shares.
The list
First, I’d look for shares that offer an above-average dividend yield. The current average yield for FTSE 100 firms is around 4%. So I’d be aiming for something greater.
Next, I’d want to see affordable dividends. I don’t want to buy shares in companies that might cut their dividends any time soon. It can happen, especially if the business is uncertain about its future earnings.
As dividends are typically paid from earnings, I’d look for a dividend cover greater than one. Dividend cover is measure of affordability and it looks at how well a company’s dividend is covered by current earnings.
One factor that provides some comfort is how long a business has been paying dividends to shareholders. Ideally, the best dividend stocks will have a long history of distributing consecutive payments. Some established shares have a dividend record spanning multiple decades.
I’d consider that to be safer than a business that switches its dividends on and off like a light switch.
Lastly, I’d look for rock-solid balance sheets. I want my selection of dividend stocks to survive over many years. To do so, I reckon it needs to have low levels of debt and high levels of cash flow.
Which dividend stocks?
So let’s look at which income stocks meet my criteria right now. First, I’d consider energy giant BP (LSE:BP). With a forecast dividend yield of 4.5%, it’s one of the lowest-yielding stocks in my list.
That said, I also think it’s the safest. That’s because it has a particularly large dividend cover of 5.9x, implying it has more than enough earnings to be able to sustain its payout.
The energy sector is in focus right now. Russia’s war in Ukraine has led to the supply of gas and oil being severely restricted. As countries seek to diversify their energy sources, shares like BP could remain in demand for the foreseeable future.
Bear in mind that there are some risks of higher taxes on excess profits. That said, with the new UK Prime Minister in place, I think that is now less likely.
Also, if the world enters a deeper recession, lower oil prices are possible. In this scenario, BP’s earnings and cashflow could suffer.
One factor that gives me some comfort is that BP has a long history of paying dividends. In fact, it has been making regular payments for over 30 years. This level of reliability makes BP one of the safest dividend shares that I would buy right now.
Similarly, I’d also consider iron-ore miner Rio Tinto, which offers a whopping 12% yield and a rock-solid balance sheet. I’d also look at Phoenix Group Holdings. This pensions business is on an 8% dividend yield. I particularly like that it has 13 years of history. Six of these years even experienced back-to-back dividend growth.