Successful income investing isn’t just about finding those dividend shares with the biggest yields. Even those whose near-term dividend forecasts look robust should often be avoided.
The key to making a decent passive income is to find UK stocks that pay strong dividends that can be sustained over the long term. This is why I continue to ignore many of the FTSE 100’s most popular dividend shares.
Here are two blue-chip stocks that offer yields above the 3.6% FTSE index average. Which should I buy, and which should I avoid like the plague?
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J Sainsbury
Food retail is one of the most stable industries out there. People need to eat during good times and bad, right? So in theory, profits at industry giants like Sainsbury’s (LSE:SBRY) should be strong enough to support big regular dividends.
But I’m not convinced. Instead, the strain of growing competition makes this an income stock I’m avoiding at all costs. Heavy discounting to win customers is driving margins through the floor, and that of Sainsbury’s crumbled to 2.95% between April and September.
The scramble to slash milk prices last week provided a useful snapshot of the price wars battering the supermarkets. Within a few hours of each other Sainsbury, Tesco, Aldi, Lidl, Asda and Morrisons all slashed prices as the race to the bottom intensified. It’s little wonder that sector profits are plummeting.
Last week Sainsbury’s also took the major step of introducing its ‘Nectar Price’ programme that offers loyalty scheme members the chance to buy certain goods more cheaply.
The move could help it pull more punters through the door. But it also threatens to drive its wafer-thin profits margins even lower. The pressure on the business to continue on a path of earnings-destroying discounts will keep rising too as value chains Aldi and Lidl expand their store estates.
So I’m happy to ignore Sainsbury’s shares despite its 4.4% dividend yield for this fiscal year. I fear its days of offering delicious dividends could be coming to an end.
Rio Tinto
I’d rather use any cash I have spare to invest to buy more Rio Tinto (LSE:RIO) shares. I expect profits here to grow strongly over the long term as a new commodities supercycle gets under way.
Dividends from mining shares can be more turbulent than those at other FTSE 100 shares. When economic conditions worsen and raw materials demand falls, profits and dividends can suffer badly.
Yet over a long-term perspective I believe Rio Tinto could deliver excellent dividend growth. This is because the materials it produces — iron ore, copper, aluminium and lithium, for example — should all rise strongly in price over the next 10 years, driving profits higher.
Trends like increasing urbanisation and the green energy revolution will push consumption of these materials sky high. But based on current mine development programmes supply will struggle to catch up, meaning values of these key materials could rise strongly.
Today Rio Tinto shares carry a mighty 6.8% dividend yield for 2023. This is a share I expect to deliver big shareholder payouts for many years.
