MoneyMagpie

Nov 06

How to choose high dividend shares

Reading Time: 7 mins

Instead of leaving your spare capital in a savings account with a paltry interest rate, consider investing in high dividend shares.

Shares work in a few ways. You can invest long-term to grow your money over time – or aim for ones that pay out high dividends each year to form an income.

A great tactic is to invest in high dividend shares and use the payments to re-invest in further stocks and shares. This cycle will grow your money over time.

Shares scare many people new to investing, as they know they could lose money as well as grow it. That’s true – but if you put your cash into a low-interest savings account, you’re also losing money over time due to inflation! So, shares can be a great way to invest and see real growth.

High dividend shares aren’t as tricky to invest in as you may think. This Moneymapgie guide will walk you through the basics of shares and dividends. 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?

A company can sell bits of itself to people via the stock market. It decides how many bits – shares – it’ll offer, and how much the total share amount is worth. This amount is divided by the number of shares available, which makes up the share price.

For example, if there are 100,000 shares available, and the total cost of buying all of them would be £100,000, each share costs £1. This share price goes up – or down – depending on the company’s performance. So, sometimes your share that you bought for £1 will be worth £0.80 and sometimes it’ll be worth £1.20.

When you buy shares, you become a shareholder in the company. That means you’re kind of like a part-owner of the company. A company pays out a proportion of its profits to shareholders – known as dividends – regularly, usually every six months.
The total amount of money you’ll get each payment cycle will be the rate of the dividend x the number of your shares.

Let’s talk about dividend yields

You’re here to find out about 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-yield companies may not fit well with your personal ethics – for example, Imperial Brands offers 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.

Some companies don’t pay out dividends at all – instead, they reinvest the money into the business. This is thought to improve 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.

Who would benefit?

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.

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.

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.

Once you’ve invested, keep an eye on the company’s performance. Historic performance has no reflection on future 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 invest in different companies instead.

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.

However, companies don’t like doing this and it’s not a common or frequent thing. It gives them a bad reputation and means investors lose trust in them. To avoid it, you may see companies that have a particularly great year not increase their dividend rate. Instead, reinvestment of profits aids business growth and protect against economic downturns in the future.

However, by picking wisely which company you wish to invest in, you reduce the risk significantly. 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.
  • The sector the company is in – e.g. oil and gas, media, retail. Is this a sector that is relatively stable or could there be big shocks which would affect the company’s ability to pay dividends?

Also, see below for more information on how to choose dividend shares.

What high dividend shares should I buy?

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.

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?

What’s the difference between stocks and shares? A share is a unit of ownership in a company – the stock is the group of the shares. So, when we talk about stocks, we’re really saying ‘units of shares’. However, you can also own shares in a single company, rather than investing in companies only listed on the stock market.

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.

Useful reads

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

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John Kingham
John Kingham
5 years ago

Hi Marc, excellent article, thanks.

I think the key point you make is not just chasing the highest yielding shares (which is a dangerous game to play) but to look for reasonably high yield shares from companies that have a long and consistent history. Not necessarily raising the dividend every year, but certainly paying one every year, backed up with consistent profits, low debts and other desirable features.

Marc Crosby
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Marc Crosby
5 years ago
Reply to  John Kingham

Thanks for your kind words and your useful advice!

Phillip Moore
5 years ago

One thing you didn’t cover is ETF’s. (Exchange traded funds). These are simpler and cheaper than Mutual funds and offer the chance to track a ‘dividend index’. What is good about this is that the saver doesn’t even have to pick out the shares. Instead they can simply invest in the index and accrue the dividends. It is also cheaper in terms of service charges which is an important consideration when it comes to generating longer term returns.

Pete Southern
6 years ago

Useful article. I have been researching different shares that are paying good dividends lately for an article I am writing. Thanks, I gained some insight.

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