There’s a lot to like about dividend shares. For one, they can make an excellent source of passive income.
Once the shares are bought, there’s very little left to do except wait. Long-term investments require a long-term mindset, after all.
The thing I like about dividend shares is the regular income. I can then choose what to do with it. If I don’t need it right now, I can reinvest it to buy more shares.
Passive income stocks: our picks
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Doing so can have a snowball effect after several years, due to the compounding effect.
Finding the best dividend shares
I’d begin by searching for quality shares that offer both growth and income. After all, dividends need to be paid from earnings. So growing earnings can lead to growing dividends.
I’d also look for a long track record of consistently paying dividends. This shows a company’s long-standing approach to distributing cash to shareholders.
Of course, there’s no guarantee that earnings will grow and no certainty that dividends will continue to be paid. But a substantial dividend history can reduce this risk.
Risk can also be lowered by owning a selection of shares, across a variety of sectors. Doing so avoids putting all my eggs in one basket.
Digging for growth
One large-cap share that meets this criteria is Footsie mining giant Rio Tinto (LSE:RIO). It has consistently paid dividends for over a decade.
Bear in mind that it’s a cyclical business though, and demand for its iron ore can fluctuate. But as a low-cost producer, I reckon Rio could withstand such swings in demand.
Also, more than half of its sales are from China. When China expands construction projects, it can have a material effect on Rio’s earnings. But of course, the opposite is also true.
Future growth is likely to come from metals needed for the energy transition and ongoing urbanisation. Rio expects demand to grow by 3.9% per year for the next nine years.
It’s all about the dividend
For shares like Rio Tinto, dividends can have a weighted effect on total returns. For instance, over the past decade, its share price has risen by around 5% a year. If that sounds mediocre, I’d probably agree.
But by factoring in dividends, its total return amounted to a healthier 10% a year. That significantly beats the FTSE 100 average of 6%.
Right now, Rio has a dividend yield of 6.5%. It also ticks some boxes when it comes to business quality. For instance, it offers a return on capital employed of 16% and an operating profit margin of 27%, both meeting my double-digit requirement.
Just like Rio Tinto, I can find several other FTSE dividend shares that tick my boxes. IG Group and BP come to mind. If I had available cash, I’d buy all three to target a solid second income for life.
