Last year, Royal Dutch Shell announced that it was cutting its dividend for the first time since the Second World War. I didn’t own the stock at the time. However, it woke me up to the fact that getting income from top dividend stocks isn’t a given. There are plenty of issues that could cause my dividend income to fall. To counter this, here’s how I’m trying to not only maintain my dividends but also increase them going forward.
Good cash generation
The first way I’m trying to do this is by targeting top dividend stocks that have increasing free cash flow or good cash generation. The more free cash that the company can generate, the more is left to be paid out to shareholders.
Various things impact the cash flow and generation. The economic climate is one of them. Over the past year or so, business has been tough. This has meant some companies have turned to issuing debt in order to have enough money to see them through the difficult period. This isn’t good for me as a dividend investor, as the funds will be focused on the business, not the dividends.
Another point is the sector. Insurance and other financial services are known to have very good cash generation rates. So this is one area that I’d look to for future top dividend stocks. The higher free cash flow, likely the higher income that will be paid out to income investors at the end of the financial year.
High payout ratio
A second way I can try and increase my income is by buying stocks that have a high payout ratio. The payout ratio is the proportion of earnings that are paid as dividends versus being retained in the business. Some firms state the specific percentage, others leave it more flexible. Either way, I can work out this ratio myself.
The benefit of a high payout ratio is that if I’m happy with the current yield, then I could see my income increase in the future. For example, let’s say a stock yields 5% with a 50% payout ratio on profits of £1m. If the company has a strong 2022 and makes profits of £2m, the 50% payout ratio means my dividend has doubled in size!
One risk here is that the payout ratio can work against me. If profits fall, then logically my dividend is also going to fall.
High-yielding dividend stocks
A final way I can try and boost my income is by looking for top dividend stocks with a higher yield than I’m currently receiving. If my portfolio is averaging 5%, I can look to sell some low-yielders. From here, I’d buy new stocks that yield in excess of 5%.
A higher dividend yield will translate into more money being received. For example, having £1,000 in a stock yielding 5% gets me £50 a year. Increasing this to 6% generates an extra £10.
Even with a higher dividend yield, I do need to watch out. The yield can still change after I have bought the stock. This would happen if the company decides to cut future dividends. But overall, by tweaking and looking at different financial ratios and figures, I should be able to find top dividend stocks to see me forward.
