How to choose high dividend shares

Jasmine Birtles 1st Apr 2021 5 Comments

Reading Time: 11 minutes

If you’re looking for a regular income, or you want a successful investing strategy, one of the best things you can do is to invest in high dividend shares.

If you are growing your wealth a great tactic is to invest in high dividend shares and use the dividend payments to re-invest in the company. This cycle will grow your money over time. In fact studies show that dividends contribute a huge amount to the total return on your stock market investments.

If you need to live off your investments then picking dividend-bearing companies and funds is a much more lucrative place to put your money than savings accounts or even bonds.

High dividend shares are not as tricky to invest in as you may think. This MoneyMapgie guide will walk you through the basics of dividend-bearing shares. By the time you’ve finished reading, you’ll know what to look for when choosing a company to invest in.

• What are shares and dividends?
• Let’s talk about dividend yields
• Who would benefit?
• What do I get from it?
• Just how risky is it?
• What high dividend shares should I buy?
• How do I go about buying high dividend shares?
• Bill Kay, dividend investor
• Useful reads

 

What are shares and dividends?

A company can sell a share of its profits and losses to people via the stock market. It decides how many shares (or stocks) it’ll offer, and the market decides what they’re worth.

If there are 100,000 shares available in a particular company, and the total cost of buying all of them would be £100,000, then each share costs £1. This share price goes up – or down – depending on the company’s performance, how popular their sector is (retail, pharma, technology etc) and how popular the whole market is at any given time. So, sometimes your share that you bought for £1 could be worth £0.80 and sometimes it’ll be worth £1.20. Later on it could be worth £50 if the company does really well.

When you buy shares, you become a shareholder in the company. That means you’re a part-owner of the company. A company that is doing well tends to pay out a proportion of its profits to shareholders – known as dividends – on a regular basis,. It’s usually every six months that shareholders get a pay-out.

The total amount of money you’ll get in each payment cycle will be the rate of the dividend times the number of your shares. So if the dividend per share is £1 and you have a hundred shares you will get £100 in that round.

 

Let’s talk about dividend yields

What we want is high yield dividends. This means a company gives a high percentage of profits to shareholders compared to the price of each share.

Remember: you need to look at the entire company history, product, and ethics before you invest. Some of the highest-yielding companies may not fit well with your personal ethics – for example, Imperial Brands has tended to offer a yield over 10%, but it is a tobacco company, which some people may not want to invest in.

Other companies may have a lower yield on their dividends but have less risk attached to the shares. These won’t pay out so much on dividends but offer a lower-risk option for new investors seeking to grow their wealth slowly over time or for retired people looking for a regular income that is not too risky.

Some companies don’t pay out dividends at all – instead, they reinvest the money into the business. This is thought to improve the overall success of a business, but actually, historical earning growth appears to be highest when payout ratios are high, too. This may be due to companies paying out profits to shareholders using their remaining profit for reinvestment more efficiently with less financial waste.

Amazon is an example of a company which doesn’t pay dividends.

Who would benefit from dividend shares?

If you have a solid lump sum sitting in a cash savings account earning a meagre interest rate at the moment, consider investing some of that instead.

High yield shares suit people who are about to retire, or are already retired and want to receive an additional regular income other than their pension.

However, shares can be a risky market, which is why it’s important to diversify your portfolio. That means investing in shares in different companies as well as having other investment streams, such as a personal pension, gold or gilt funds, or even property.

Once you’ve invested, keep an eye on the company’s performance. It’s important to make sure your investments perform well: every share price fluctuates month-to-month, but if you notice a consistent downward trend over time it could be time to move your money to a different company.

Investing in dividend shares is also good for people building up their wealth though. In fact, according to a report by the investment house Janus Henderson, “The Barclays Equity Gilt Study, which was published in April 2019,  shows the nominal performance of £100 invested in cash, bonds or equities (the UK All-Share Index) between 1899 and 2018: cash would be worth just over £20,000 today; if invested in gilts, the same £100 would be worth close to £42,000; however, £100 invested in equities in 1899 would now be worth around £2.7m, manifestly evidencing what excellent long-term investments shares have been.”

 

What do I get from it?

Each company deals with its dividends differently. However, you can expect some similarities in each company you’ve invested in:

• Dividends are usually paid twice a year
• You can choose to receive cash dividends into your bank account, or reinvest them to buy more shares

If you don’t want – or need – the regular cash payment, reinvesting can be the best way to see the greatest return on your initial investment. If you hold the shares for several years and always reinvest, you’ll end up with significantly more shares without paying anything extra!

 

Just how risky is it?

As with buying any shares, there is no guarantee when you buy shares with high yield dividend offerings. No company has to pay out dividends – and they can change their policy at any time.

During the financial crash of 2009, 202 UK companies cut their dividends to protect the base operational efficiency of their business. Instead of paying shareholders, they reinvested to continue thriving (or at least, prevent failing) in a turbulent economy.

Also in 2020 many companies pulled back from giving dividends as they were facing such tough times. This is one of the reasons why AJ Bell has predicted that dividends in 2021 will grow by 21%.

Companies that have traditionally paid out a dividend don’t like cutting the pay-out and it’s not a common or frequent thing. It gives them a bad reputation and means investors lose trust in them. In fact you may see companies that have a particularly great year not increase their dividend rate but instead, reinvest profits in order to help business growth and protect the company against having to cut the dividend in the future.

However, by picking wisely which company you wish to invest in, you reduce the risk significantly.

To pick a good payer you should look at:

• Their history of paying out dividends. Those that have regularly paid – and particularly those that have consistently increased their pay-out – are generally a good bet. Nothing is certain but if a company has a culture of paying out decent dividends then it’s tough for them to reverse that trend.
• The sector the company is in. Some sectors have traditionally paid out dividends more than others, such as oil and gas, food production, tobacco, travel, pharma.  Again, nothing is certain but you may find that favouring a particular sector for dividends can be lucrative.

Also, though, if you’re going for dividends you can to a large extent ignore price. Ideally you will buy when the price is lower than usual but even if you buy at the ‘proper’ price, if it regularly increases its dividend then you will be quids in after a few years.

 

Which high dividend shares should I buy?

We can’t tell you exactly which company to invest in (although we can make suggestions), but here are the steps to take when deciding for yourself which company to invest in for dividends and creating a successful investing strategy.

Take a look at the company’s history

• For a safe investment you should only consider companies that have consistently increased their dividends over the last twenty years. A company that regularly raises their dividends will also go some way to protecting against inflation. Take a look at the Dividend Champions list to see which companies have consistently raised their dividends. Check if the raises beat inflation, too.
• You are best opting for a blue chip company, which means the company has a strong national reputation and is consistently able to operate profitably. Check out this list of blue chip companies that offer dividends here.
• Take a look at the company’s interest coverage ratio. The interest coverage ratio is used to determine the company’s ability to pay interest on its outstanding debt. It is calculated by dividing the company’s earnings before tax by the company’s interest expense of the same period. If the company can’t cover its debts then it will not be able to pay you a dividend. An interest coverage ratio of 1.5 or lower is risky and, if you want a securer investment, you should be looking for a ratio of 3 or above.
• Also check out the company’s sustainable growth rate. The sustainable growth rate is the maximum amount of growth a company is capable of without needing to borrow more money. Try looking for a growth of 7% or above for a safe investment. It is important, however, to ensure that this trend is likely to continue.

Take a look at best dividend stocks UK for more information.

 

Look for lower payout ratios

• The percentage of profits paid out to shareholders is the payout ratio. A high payout ratio will be one that pays out a high percentage of the company’s profit to the shareholders. This may sound great, but it increases the risk for you as an investor. The higher the payout ratio, the more dependent the dividend will be upon the company making a good profit. Lower payout ratios are more secure and less likely to be affected by how much profit the company is making.
• These numbers change continuously as companies update their accounts each year. Historical behaviour can be an indicator – but as we’ve seen in 2019 with major companies like Marks and Spencer falling off the FTSE, anything can happen. Some ratios may look incredible – like BP’s current 93% (as of October 2019), but there are questions about how sustainable this really is.

 

Buy low

• It is advisable not to buy a stock when it is near its 52 week high. When the stock is at its highest, the dividend yield will be at its lowest. As an investor you want to buy at a low price and be able to sell at a high one. This is not an absolute rule; for example you shouldn’t buy stock if it’s at its 52 week low because there may well be a reason why that share is being sold so cheaply. You can find current share prices on the London Stock Exchange website.

 

Invest in a company where the management receives dividends

• It makes sense to invest in a company where the CEO receives dividends. They will likely be less inclined to cut the dividends as they too benefit from receiving them.

There’s no guaranteed way of ensuring you’ll make a good return, but if you follow this advice then you’re giving yourself some security. There are also more specific strategies that you can research and follow if you wish.

 

How do I go about buying High Dividend Shares?

We have a really comprehensive guide to buying shares right here – but here’s the quick version of it!

You can buy shares through a stockbroker, a stocks and shares ISA, individually through an online account or, (unlike stocks such as index trackers or ETFs), direct from the company.

If you go via a stockbroker, they can advise you on the best funds (or companies) to invest in based on your long-term financial plans and the amount of risk you’re willing to take. They’ll manage your money once you’ve bought the shares, too – and this comes at a higher price.

A stocks and shares ISA is something everyone over the age of 18 should have! Choose from individual funds  or select a ready-wrapped ISA product. These give you the option to invest in pre-selected funds based on your chosen risk level. A fund means you’re paying into a pool of money that is used to buy shares in a group of companies. Again, you can choose a managed product (with higher fees but less hands-on investment required) or self-directed shares management. Check out our guide to equities ISAs here.

You can use an online platform like eToro or Interactive Investor to manage your shares without high management fees (although there may be fees such as for transactions). You put money into your account and then buy shares online using those funds, and can buy and sell as you wish.

Some companies sell shares but aren’t listed on the stock market. If there’s a company you’d like to invest in, but you can’t find it on the FTSE or other stock market listings, approach them directly. Every company has their own way of processing share purchases, so ask the company to explain their policies before you buy.

 

bill kay, dividend investor

Bill Kay is the former City editor of The Times and former Money editor of The Sunday Times and he’s been investing in high yield dividend shares since 2006 when he sold his house and moved, for a few years, to America,  From the sale of his house he bought a new place in the States for half the cash and invested the rest in the US stock market, picking high-yield dividend shares in order to give himself an income.

“I wanted to go solid and reliable, not flash companies” he says. ” i came across Dividend.com which had good information  including a league table of dividend aristocrats. The AIC in the UK has done something similar here too did something a few weeks ago about investment trusts that have paid dividends for fifty years or more.

“At my age, with employment being precarious I started investing in dividend-bearing shares because I was looking ahead for sources of income. I would now argue that dividends should not be age-related. Investors should go for dividend companies as they tend to give best all-round return. If you look up ‘total return of shares’ dividends form 30-50% of the total return. We are all brainwashed into looking at share prices but actually, long-term the best thing is to buy and hold and reinvest dividends because if has a compounding effect.

“I think the way boardrooms work is a clubbable thing – with a lot of companies, especially if they’re family controlled, it becomes a point of honour to pay dividends if they’ve always done it.

“I went for deliberately conservative companies: generally ones you’ve heard of in industries you’ve heard of. In America I avoided retail but went for AT&T, British American Tobacco, oil companies and generally companies that make things we use. My yardstick was a minimum yield of 4% and that cut out a lot of companies like IBM which pay regular dividends but you’re starting at a very low level. That sort of thing is good for someone in their 40s but I was 60 so I needed good returns right then.  The younger you are the more you can go for solid dividend payers with a lower yield.

Bill returned to the UK in 2018 but was not allowed to invest here until January 2020. “Again i invested in a range of stocks like the American ones, utilities, tobacco and quite a few investment trusts that paid dividends” he says. “I like pharma as they’re good payers and  very reliable. However, the market then collapsed! I’m trying to recover from that now. It’s looking good though. There’s a lot of recovery going on, with the economy waking up and a lot of companies going back into paying dividends. By the end of this year I’ll be back on an even keel.

 

Useful reads

There are several good books out there that will help you learn the basics of buying and trading high dividend stocks.

• Beat the Banks by Jasmine Birtles
• The Dividend Investor by Rodney Hobson
• Dividend Stocks for Dummies by Lawrence Carrel

*This is not financial or investment advice. Remember to do your own research and speak to a professional advisor before parting with any money.