One of the joys of buying cheap shares that pay decent dividends is you literally get paid for being patient. What I mean is that you bank (or reinvest) these regular cash payments, while waiting for share prices to recover and produce future capital gains.
Bumper dividends often identify cheap shares
In the long term, reinvested dividends can account for half of total shareholder returns, so I choose payments that will stand the test of time. Indeed, with the FTSE 100 today at the same level as in February 1998, the UK’s main index has recorded zero growth for 22.5 years. Thus, the only gains from the Footsie have come from cash dividends and/or reinvesting these into more cheap shares.
I’m always hunting for solid companies with strong cash flows that generate above-average dividends. Hence, I use dividend yields and dividend coverage (as well as low-price-to-earnings ratios) to identify portfolio picks.
Passive income stocks: our picks
Do you like the idea of dividend income?
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UK dividends have slumped in 2020
According to this excellent report, UK dividends almost halved in the second quarter, crashing 49.1% versus Q2 2019. This collapsed total dividends to £18bn, the lowest payout in a decade. Two-thirds of UK-listed companies cut or cancelled their payouts in Q3, slashing £14.5bn from these payments. The biggest casualties were oil producers, banks, and insurance companies, most of which paid no dividends whatsoever in Q3. As a result, their stocks have been dumped deep in the ‘cheap shares’ bin.
The UK’s five dividend darlings
Despite this decline, UK dividends are expected to be around £60bn for 2020 (down from £98.5bn in 2019). Following dividend cancellations, three of the UK’s five biggest payers have crashed out of the top table. Today, just five big businesses account for £5.9bn — or a third (33%) — of all UK dividends paid in Q3. Here they are, in order of dividend payment size (not yield):
| Company | Share price (p) | Dividend yield (%) |
| Rio Tinto | 4,452 | 6.8% |
| British American Tobacco | 2,453 | 8.6% |
| National Grid | 919 | 5.3% |
| Vodafone Group | 105 | 7.7% |
| GlaxoSmithKline | 1,322 | 6.1% |
Which of these cheap shares would I buy?
I’ve been a GSK shareholder for most of the past three decades, reinvesting my cash dividends into more shares every quarter. With GSK shares down more than £5 from their 2020 peak, I’m a big buyer of this pharma giant at current prices. Likewise, I’m a firm fan of BAT for its enormous cash flow and huge dividends (likely to be the biggest total payout for 2021). Again, BAT is firmly on my watchlist of cheap shares.
I’m also an admirer of Rio Tinto, the world’s largest miner, which paid out dividends totalling £3.65bn to shareholders last year. Indeed, I’ve described Rio as an ATM on steroids, so it’s definitely among my dividend picks. Vodafone is also on my radar, thanks to its hefty divvies and potential for capital growth. Finally, I probably wouldn’t go big on the shares of National Grid, simply because of their lower dividend yield (and higher price-to-earnings ratio). But, if pushed, I wouldn’t actually say no to NG’s shares.
To sum up, an equally weighted mini-portfolio of all five of these mega-cap dividend darlings pays an average dividend yield of 6.9%. That’s about five times as much income as the top-rated savings accounts. That’s why I’d buy these cheap shares today, ideally inside a cash ISA, to enjoy a lifetime of tax-free cash dividends and retire rich!
