Dividend stocks give me the alternative to make passive income. Depending on my objectives and funds that I can afford to speculate, the sort of stocks I select will differ. However, no matter the purpose, I would hardly ever buy the inventory that provides me the highest dividend yield in the total FTSE 100 index. Let me clarify why.
Understanding the dividend yield
Firstly, it’s necessary to know how I calculate the yield for a dividend inventory. To work out the present yield, I take the annual dividend per share and divide it by the share worth. For instance, if the complete dividend paid over the final 12 months is 10p and the share worth is 100p, the dividend yield is 10%.
The cause why the calculation is necessary is due to how the yield modifications. Two components affect the motion of the yield. If the share worth will increase and the dividend stays fixed, the dividend yield will fall. If the share worth stays the similar however the dividend decreases, the yield will fall. The reverse applies to each these circumstances as nicely, by which case the yield will rise.
Dividends don’t receives a commission or change that always, normally solely a few instances a 12 months. So the fundamental change in dividend stocks normally comes from the share worth shifting. This is why I must be cautious about stocks with a excessive dividend yield.
Dividend stocks with an exceptionally excessive yield may be this manner as a result of the share worth has been falling. Such a fall will trigger the yield to rise. On the face of it, I would possibly simply word the yield and assume that it look unbelievable. But digging deeper would present me the share worth has been falling.
From right here, I can do my analysis and work out why the share worth has fallen. If the basic image round the firm has modified, this may very well be unhealthy information. For instance, poor outcomes or revised revenue steerage for the 12 months forward. In this case, it’s seemingly that the dividend per share can be minimize in the close to future. This will then decrease the yield.
I need to keep away from this case occurring, as a result of if the dividend will get minimize fully I would possibly must promote the inventory and look for a unique one. Alternatively, the dividend would possibly scale back, however the share worth might preserve falling. In this case, I may very well be left with a big unrealised loss from holding the inventory that can take me years value of dividend income to offset.
Sustainable dividend stocks
I can’t predict the future and what is going to occur to dividend stocks that I’m contemplating. However, I can take precautions to guard myself. In my opinion, present FTSE 100 stocks with a yield in extra of 10% would sound a warning bell in my head.
I do admit that there are always exceptions, with some stocks providing a excessive dividend yield and sustaining this over time.
On stability, I’d a lot want to personal dividend stocks with yields in the 5%-8% bracket that I assume are extra sustainable.
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jonathansmith1 and The Motley Fool UK have no place in any share talked about. Views expressed on the firms talked about on this article are these of the author and due to this fact could differ from the official suggestions we make in our subscription providers equivalent to Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we imagine that contemplating a various vary of insights makes us higher traders.