Three strategies for dividend investors - and 10 shares that do it all

With the global economy in a fragile state, stock screen expert Ben Hobson finds the stocks offering a combination of high yield, safety and quality to see you through 2023.

Dividends always play an important role in stock market returns, and that was especially the case in 2022.

For many investors, buying and holding dividend shares is very much its own discipline. But it is also true that dividends can play a part in almost any strategy or style of stock selection.

Just take Warren Buffett, one of the world’s great investors.

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Buffett has an affection for high-quality firms with durable profitability. He buys shares in companies that generate stellar sums of cash with which they can do two things. One is to retain it to grow in value, size and strength (and even buy back their own shares). The other is to pay it back to shareholders, who can then choose what to do with it.

Buffett’s investments in companies such as Apple Inc (NASDAQ:AAPL), Coca-Cola (LSE:CCH), Bank of America (NYSE:BAC), Chevron Corp (NYSE:CVX) and American Express Co (NYSE:AXP) deliver hundreds of millions of dollars in dividends to him each year. He loves those companies to grow in strength so that their profits are protected, but he also loves the dividends too.

At a smaller scale, exactly the same goes for regular investors. A portfolio of high dividend-paying equities has the potential over time to deliver capital gains and cash payouts that can be retrieved or reinvested.

Research by the investment firm Schroders shows that in the 20 years between 2000 and the end of 2019, the FTSE 100 index of large-cap shares produced an average annual share price return of just 0.4% - it was barely unchanged.

But when you add in the impact of reinvested dividends to that calculation, the return jumps to 4% per year, or 122%.

You can see just how important compounded dividend gains can be over time.

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The perennial challenge for investors is that companies are prone to changeable conditions and their prices (and dividends) can be volatile.

A great example of this was during the Covid pandemic in 2020. Faced with sudden economic fears, companies cut their dividends and share prices fell.

Fortunately, this double whammy for investors unwound quite quickly. Prices rebounded within months and the bulk of dividend payouts were back to pre-pandemic levels by the end of 2021.

This year we have seen different challenges. Fears over rising inflation and recession have driven down share prices across the market. When it comes to dividends the latest statistics suggest that some sectors are seeing bumper payout growth, while others are more subdued.

The overall payout from UK shares in the autumn reached £31.4 billion, according to equity services firm Link Group. The total for 2022 is expected to hit £97.4 billion.

Among the highlights, companies generating sales in US dollars, as well as those in the oil and gas, mining, finance, industrials and consumer services sectors have been the strongest this year.

Three strategies for dividend investors

For investors, there are three key factors to consider when it comes to dividend strategies: yield, growth and safety.

Dividend yield is the classic measure of income paid by a security; it’s the relationship between the dividend per share and share price. The higher the yield the more attractive it is to income investors. But excessive yields can be a red flag that the market doesn’t quite believe in the dividend or the company, or both.

Yields this year have been nudged higher because of falling share prices, leaving some to see this as a good opportunity to snap up solid payouts at attractive prices.

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Dividend growth is a measure of the compound growth rate over time, or simply the number of years a company has increased its payout. It is useful because it points to companies that are growing - increasing the chances of having both a rising share price and a rising dividend. Yields tend to be lower in dividend growth shares, but the comfort of a progressive, upward trend in the payout can be appealing.

Dividend safety is about the reliability of the payout and the company actually making it. Strong profitability, low debt and flexible, efficient finances are desirable factors when it comes to finding companies that can sustain and grow their payouts. Those with high yielding shares in particular, should be checked to ensure that the dividend isn’t obviously at risk. 

Safety can be judged with basic measures like the size of the company (the larger it is, the less speculative it is likely to be). You can also use more specific checks like dividend cover (the extent to which profits cover the payout), or even a financial health trend checklist like the Piotroski F-Score (the higher the score out of 9, the better).

To get an idea of the kind of companies that pass all of these rules (and there aren’t many), this screen takes yield, history and financial strength as the main focus.

Combining dividend yield, growth and safety is very much a personal choice. Those who prioritise high yield may prefer to compromise on growth, while those that want more of a growth track record, may be willing to accept a lower starting yield. Either way, dividend safety is likely to be a must-have.

This screen looks for shares with a market cap of at least £500 million with a forecast yield of more than 4%. It sorts the results based on the dividend growth rate over the past five years. All have robust safety indicators, with dividend cover of more than 1.5x forecast earnings and F-Scores of six or more (out of nine).

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The strongest growth has been seen in mining companies Rio Tinto (LSE:RIO) and Glencore (LSE:GLEN), where five-year compound dividend growth rates stand at more than 30% and the forecast yields are 6.4% and 8.1% respectively. 

Among the four industrial sector shares passing these rules, contractor Morgan Sindall (LSE:MGNS) has the highest yield (6.7%) and best growth record (21.3%), while sales and marketing support group DCC (LSE:DCC)has the largest market cap and highest dividend cover (2.4%). Hire company Redde Northgate (LSE:REDD) has the highest F-Score (8), but doesn’t quite have the dividend growth record of the fourth industrial share in the list, Vesuvius (LSE:VSVS), at 5.1%.

Among the consumer-facing stocks here are the house builder Vistry Group (LSE:VTY), pets retailer Pets at Home (LSE:PETS) and supermarket giant Sainsbury (J) (LSE:SBRY).

Outlook for 2023

With high inflation and the prospect of recession very much front-of-mind for investors in the year ahead, it seems likely that share prices will remain under pressure in places. That means the income on offer from dividend-paying shares will once again be an important source of returns.

As we saw in 2022, a focus on higher-quality, profitable firms with strong margins, robust finances in defensive sectors may offer more resilience. So whether you prioritise high yield or strong payout growth, a focus on safety and quality should be a core component in any dividend strategy in the year ahead. As always, careful research is essential.

Recent experiences show that dividend cuts can be swift when companies sense economic headwinds. So it is well worth having a strategy for finding payouts that you can rely on.

Ben Hobson is a freelance contributor and not a direct employee of interactive investor.