Dividend shares offer me a great way to pick up passive income from my investments. Money that I invest into the market can be used to generate me cash in the process, via dividend payments. As a shareholder, I’m entitled to such payments whenever they are released, usually every six months. If I’m new to using dividend stocks to generate income, here are five things I’d want to know.

Working out the numbers

First of all, one of the basic tools I need to be comfortable with is the dividend yield calculation. This allows me to compare different dividend stocks by having a measure that carries through the entire market. I take the annual dividend and divide it by the current share price. For example, if the dividend per share for the past year was 10p and the share price was 100p, the yield would be 10%.

Each stock has a yield, even if it’s 0%, meaning the company isn’t currently paying out a dividend. This ties in with my second point, that I need to be careful how I compare stocks. Some might just look at the dividend per share figure. Yet just because a stock pays a large dividend per share, doesn’t mean the actual dividend yield is large. If the share price is also high, the yield might be lower than other stocks.

Sustainable dividends

A third point is that just because the dividend yield is high, doesn’t mean I should buy it. I need to look at the reasons behind the dividend stock having a high yield. For example, if the share price has been falling, this will artificially increase the dividend yield even if the dividend per share has stayed the same. If the company is in trouble, it might only be a matter of time before the dividend gets cut. In this case, my investment might not be as lucrative as initially thought.

I also need to look at the sustainability of the dividend being paid out. Measures that I like to look at include the dividend cover and the payout ratio. These two calculations can be worked out easily. They give me a good indication as to whether the company is likely to be able to maintain the current level of dividend payments into the future.

Diversifying my holdings

The final point I would stress about dividend stocks is that it’s better to own a portfolio of stocks instead of just a couple. This helps to blend my average dividend yield, and reduce my risk. If I own a dozen stocks and one cuts the income payout, it won’t be the end of the world. But if I only hold a couple of stocks, then I’m in trouble.

Overall, noting the five about points should help me in the future when looking to generate income from dividend stocks.

Leave a Reply