There are so many dividend shares with big forecast yields right now, it’s hard to know where to start. So how can we pick the best ones to buy?
Well, it’s easy, isn’t it? Just go for the biggest dividend yields and those will pay us more cash than the rest. Well, it’s possible that could work out well.
In fact, I often think I should run some sample portfolios buying the FTSE 100 stocks with the 10 biggest yields at the start of each year. Do that for each year of the past decade, and see where they would have gone.
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Biggest yields?
But I think it could be a costly mistake to just go for the biggest yields. I reckon there’s a fair bit more to it, if we want to minimise risks and maximise gains.
Firstly, we often see a big yield simply because the share price has fallen. It’s not because the stock is throwing off huge quantities of cash that the board wants to hand over to us.
Broker forecasts are often way behind the times. And when a company hits problems, it can often be months before they update them.
A big yield doesn’t always mean a big total return either.
Cash not covered
Look at Vodafone. The phone giant did cut its dividend a few years ago, but it’s been paying out big sums for years. This year, there’s a whopping 10.5% on the cards.
So we’d want that, right? Well, the problem is that the earnings to cover it aren’t there. And partly as a result of handing out more cash than Vodafone has been earning, the share price has been on a slide.
It’s down 58% in the past five years, and down 67% since the highs of 2015. That’s not a good result.
Strong cover
So that’s what I most look for, cover by earnings.
Vodafone’s 2023 forecast earnings would only provide 67% of the dividend. But Aviva would have its 8% yield covered 1.6 times by earnings. And at British American Tobacco, we’re looking at 8.7%, with 1.5 times cover.
Give me a well-covered 8% yield over an uncovered 10.5% any day.
I also want to see consistent dividends. Rio Tinto, for example, headed the list for much of 2022. But it doesn’t make the top 10 for 2023.
Glencore, in the same cyclical sector, offers a 10% forecast. But in the past decade, it’s cut its dividend three times.
Stable dividends
Investment trusts often pride themselves over their track records. Known as ‘Dividend Heroes’, some have lifted their dividends for more than 50 years in a row.
My choice, City of London Investment Trust, has posted 57 straight years of rises. And it’s on a 5.1% yield now. I’d much rather have a 5% yield for decades than a bigger one that could be gone tomorrow.
So, to sum up, I go for a good yield, but rarely the biggest. I want to see the earnings and cash to back it. And I want a good long-term track record.
