Dividend shares can be an excellent source of additional income. Not only would I receive regular cash payments but I should also benefit from long-term growth of the underlying businesses.
The FTSE 100 index is home to a number of dividend-paying stocks. And although the average dividend yield for these shares is 3.8%, some offer as much as 10%.
Quality shares
Now, a double-digit yield might look tempting, but a word of warning. It might not be sustainable. Dividends aren’t guaranteed and can be cut or suspended by management.
Should you invest £1,000 in SSE right now?
When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if SSE made the list?
That’s why I’d focus on quality dividend shares. I’d consider these to be consistent payers that operate strong and sustainable business models.
As dividends are typically paid from earnings, I’d want to see stable or growing profits.
Warren Buffett frequently talks of liking businesses that have a moat. By this, he means a sustainable competitive advantage. This could be a strong brand or superior technology that allows a company to earn a high profit margin.
Companies that have a moat are likely to offer sustainable dividends many years into the future, in my opinion.
So, with £10,000 to invest in dividend shares, I could buy a fund such as ishares UK Dividend ETF (LSE:IUKD). It currently offers a yield of around 6% and holds over 50 stocks.
Alternatively, I could select my own choice of shares. By doing so, I’d have more control over what I own.
It could also result in a larger dividend income if I choose sensibly.
Several baskets
There are a few things to bear in mind when picking individual shares. For instance, if I had £10,000 to invest in dividend shares, I’d for for a selection of five to 10 stocks.
For me, owning just one or two stocks would be too risky. If one of these companies was negatively impacted, it would have a significant impact on my total investment.
Diversifying across multiple stocks should limit my risk. That said, I wouldn’t buy 100 different dividend shares either. Costs would be much higher, and following so many companies would likely prove time-consuming.
To avoid putting all my eggs in one basket, the stock picks should also be spread across several industries.
What I’d buy today
I’ve found several UK-based dividend shares that meet much of my criteria. But a few stand out from the crowd.
If I had £10,000 to invest in quality dividend shares today, I’d buy Phoenix Group, Legal & General, Imperial Brands, Rio Tinto and SSE.
On average, these five shares offer an 8% dividend yield. They’re also spread across a range of sectors and are profitable businesses.
Bear in mind that investors would still need to monitor these individual shares. And often other shares might become more suitable over time.
But right now, with strong business models and established brands, I’m comfortable that all five will continue to distribute dividends in the years to come.
