How to buy and invest in dividend stocks in the UK

How to buy and invest in dividend stocks in the UK

You can buy dividend stocks with us, which enables you to own company shares outright. When you invest through our share dealing platform, you can get top UK dividend stocks from as little as £3 commission.¹

Buying and holding shares is something many investors do, but dividend stocks can be especially attractive. Not only will you have the potential to make a profit if the company’s share price appreciates, you can also make additional income in the form of dividends.

Investing in dividend stocks makes you a shareholder in that company. This means you may also get additional privileges like voting rights in company decisions.

Here’s how to buy UK dividend stocks with us:

1. Create a share dealing account: you’ll get access more than over 12,000 stocks, over 2000 ETFs, investment trusts and more. If you already have an account, you can just log in
2. Do thorough research and choose the right dividend stocks for you – you can use this article as a guide
3. Once you’ve chosen your shares, buy them with your share dealing account
4. Monitor your investment and keep up to date on any dividend or company news

How are stock dividends paid to my share dealing account?

As soon as we receive a dividend payment on any of the stocks you own, we’ll credit your share dealing account.

Once this has happened, it will appear on your ledger as cash.

When you’ve received your dividend payment from us, you can choose to either reinvest or withdraw it.²

Read more about how you’ll receive dividend payments

What are dividend stocks?

Dividend stocks are shares in companies who are known for giving their shareholders dividends. While many companies give dividends sporadically or not at all, dividend stocks have a reputation for regular, predictable dividends. They often have a progressive dividend policy too – meaning their dividends grow in size progressively with each payout.

How do dividends work?

When a company has been profitable or otherwise successful, a well-known practice is to give dividends to their shareholders – a payment per share to all their stockholders released on a specific, prearranged date. The more shares you own, the more dividends you’ll receive.

Many companies only pay dividends when business has been exceptionally profitable, and pay out of the overflow of profits made. However, those seeking to preserve their reputation as a dividend stock will still pay out dividends from their retained earnings – even if they haven’t been as profitable.

Dividends highlight one of the most attractive things about investing (as opposed to trading on) shares – you are a part stakeholder in the company if you’re a shareholder, which entitles you to share in its success.

However, it’s important to note that dividend payments are by no means an obligation of companies. As such, it’s wise for investors to think of dividends as a ‘bonus’ rather than their due.

Learn more about dividends and how they work

Why do companies pay dividends?

If paying dividends isn’t compulsory, why do companies do it? Dividends are a choice that rewards shareholders (and seek to entice more investment).

Dividends can keep an existing shareholder base loyal and bring in new ones. A particularly generous dividend aims to act like a message by the company to the market, saying: ‘we’re doing well! Invest in us!’

Similarly, companies with a good track record of paying dividends in the past will seek to keep their reputation as a dividend stock in the hopes of attracting (and retaining) investors. This could lead to a virtuous cycle, where the increased investing in the stock ups the share price, gaining more interest and investment.

Dividends can be paid quarterly, annually or semi-annually.

Dividends aren’t just good for shareholders, they positively affect companies’ balance sheets, too. One of the most important figures that both analysts and investors look at when deciding if a stock is a good buy is return on equity (ROE).

ROE is calculated out of a business’ profits after tax, however, most dividends are paid directly from these profits. Analysts will take this into account and, if a company pays dividends, divide leftover profits for ROE figures by a smaller number than they initially would. This actually results in a higher ROE.

Examples of dividend stocks

Companies that are ‘dividend stocks’ are usually large and well-established, and often will continue to be profitable for a long time.

Because of this, dividend stocks tend to be blue chip companies that are listed on leading indices like the FTSE 100 or the Dow Jones. However, it’s important to remember that not all companies pay dividends, even really high profile ones. Just because it’s a household name, doesn’t mean it’s a dividend stock.

Examples of well-known UK dividend stocks are Sage Group, GlaxoSmithKline, M&G and Imperial Brands, among others.

Discover the top UK dividend stocks

Looking for good dividend stocks, you’ll likely come across the term ‘dividend aristocrats’. These companies are an exclusive few that have paid dividends regularly, as well as consistently raising their dividend payout for the past 25 years or more.

What is investing for income?

Investing for income means buying shares and ETFs with the specific purpose of generating a predictable, regular ‘cash flow’ of money from investments. In short, making an income from investing.

Dividend-paying stocks can feature prominently in ’investing for income’ strategies, as they can represent frequent payments at predictable intervals – for example, every quarter Receiving an income from dividends is a form of passive income generation – ie income that you don’t ‘actively’ have to pursue but comes in regularly, automatically, of its own accord.

Reinvesting dividends

When you receive a dividend payment, you don’t have to cash it out, but can instead reinvest. This means that you choose to put your dividend income back into the company to gain more shares.

This will compound your investment over time. With reinvesting dividends, your investment and returns increase year-on-year in a virtuous cycle which can be an exponential way to grow wealth.

Let’s look at an example to see how. Say you invested £1000 in a dividend stock’s shares worth £5 per share (200 shares). With this particular stock, you earn 20p dividend per share (4% of £5), meaning you earn £40 in dividends in the first year.

However, this is just the beginning. If the share price grew by £1 each year, and the dividends remained at 4%, you’d have made £760 from dividends after ten years and own shares worth £2800 (£14 x 200 shares). The total return on investment would have been £2560 – that’s £1800 in share price growth plus £760 from dividends.

However, if you instead reinvested the money earned from dividends, that sum would have increased year-on-year. The increase in the investment with reinvested dividends is over and above the share price growth alone. Take a look:

Find out more

Income investing vs value and growth investing

There are two other main strategies for investing used: value investing and growth investing.

While income investing often focusses on blue chip stocks at the top of their game, some investors choose to instead look for potentially undervalued stocks. Their aim is to buy shares at a lower price than they actually merit, before the stock price corrects to its fair market value. Probably the best-known example of this is a younger Warren Buffett investing in a little-known, undervalued company called Berkshire Hathaway.

Perhaps the opposite of this approach is growth investing, which instead looks at buying stocks in companies making faster or more significant gains than their market peers, in terms of profits, market cap or other factors like prominence in the media.

While value investing may focus on ‘bargain buy’ stocks that have intrinsic worth but may not have the book value to match at that time, growth investor stocks are the opposite. These are often much-hyped (and maybe overvalued) companies doing particularly well. They could also be newer companies generating lots of interest or any other stock riding high on publicity or an industry windfall (for example mining companies when commodities are doing particularly well).

How to evaluate dividend stocks

It can be overwhelming to try and pick companies that are good dividend-paying investments and will continue to be for some time. Luckily, there are a few different metrics and calculations that can help you pick a good dividend stock to invest in. We’ll unpack them below.

Dividend yield and the dividend trap

Probably the most well-known way to evaluate a dividend stock is by its dividend yield. This is the company’s annual dividends per share paid out divided by its current share price.

This will give you a figure that shows how ‘generous’ a company is with their dividends, based on how much they are valued at and what proportion of that amount goes into dividends.

Dividend yields are expressed as a percentage. Usually, a good dividend yield figure is considered anything around the 6% mark or even higher, although any dividend yield above 2% is considered respectable. However, this will vary depending on industry norms and must always be taken in the context of the market and sector that the company sits in.

However, beware the ‘dividend trap’. The dividend yield calculation aims to find companies that pay a high amount of their profits in dividends, but it can backfire. If that company’s share price has dropped significantly, this could also lead to a high dividend yield.

You may want to steer clear of these companies as a significant drop in share price could mean lower or no dividends in the future, as these are usually paid from profits.

Dividend cover ratio

The smart investor will remember that dividends are not always paid out of the overflow of profits, but sometimes out of retained earnings in the hope of attracting investors with a shiny dividend payout, even though the company has not been doing particularly well.

For these scenarios, you can calculate a company’s dividend cover ratio (sometimes called its dividend coverage ratio). This is the amount of times a company can afford to pay out the dividends it’s paying with the earnings that it’s made. This gives a good idea of the sustainability of the company overall – a crucial factor when investing over the long-term.

Generally, a good dividend cover ratio amount is 1.5 or higher. This means that the company can afford to pay out the dividends they have one and a half times over, with the earnings they’ve made. A figure below this, especially below 1 (1< cover ratio), is a sign the company has had to dip into its own coffers to afford to pay dividends, rather than paying them out of profits.

There are two different ways to calculate dividend cover ratio. The more simple route is to divide the company’s annual earnings per share (EPS), which can be found on their financial statements and in their latest financial results, by the company’s annual dividends per share (DPS).

However, most companies have two different types of shareholders: preferred stockholders and common stockholders. Preferred shares get a fixed form of dividend payment and are paid out first, while common stockholders get normal dividends as and when they occur, paid out second to preferred shares but with the added benefit of company voting rights.

In this instance, you’d calculate dividend cover ratio by first subtracting preferred shares’ dividend payments off of the company’s total earnings, and only thereafter dividing those earnings by the total ‘ordinary’ dividends paid to common stockholders.

Dividend payout ratio

Similar to dividend yield (and in some ways the opposite of dividend cover ratio), a dividend payout ratio shows how much of a company’s net earnings they’ve paid out in the form of dividends.

There are a few different ways to calculate dividend payout ratios. The simplest and easiest to understand is to divide the total amount of dividends paid by the company’s net income. So, if the company earned a net income of £100,000 and paid a total of £30,000 to shareholders in the form of dividends, that’s a payout ratio of 30%.

Another way to calculate it is to divide the dividends per share amount (DPS) announced by the company by the earnings per share (EPS) amount.

While it may seem like a higher dividend payout ratio is better than a lower one, that’s not always the case. Companies that spend a high percentage of their earnings on dividends invariably have less capital to reinvest in the business, which can hurt its prospects long term. In this way, a lower dividend payout ratio can be a good way to assess the sustainability of the business.

The importance of fundamental analysis

While all of the above calculations will help you to determine a good dividend stock, they cannot outweigh the importance of using fundamental analysis as well.

Fundamental analysis places your dividend stock in context by looking at all sorts of surrounding factors that aren’t found in ratios and yield figures alone. A good fundamental analysis will, for example, look at the following:

• How healthy the balance sheet of the company is
• Company and industry news that may affect the share price
• The state of the macroeconomic environment as a whole
• The state of that company’s industry as a whole
• Market demand for what the company’s selling
• The company’s competitiveness within that industry and its future prospects

Steps to identify good dividend stocks

1. Use a market screener to find dividend yields

   We have thousands of international stocks to choose from, which can make finding a good dividend stock seem intimidating.

   Our market screener enables you to find stocks to invest in or trade that fit your parameters. You can input your required metrics for dividend yield percentage, profit margin, company market cap, return on investment (ROI) and normalised price-to-earnings (P/E) ratio. The market screener will then give you all the companies that match your criteria. You can even choose which country these stocks should be from.

   Try our market screener

2. Analyse dividends

   The calculations of dividend yield, dividend cover ratio and dividend payout ratio are a great first step to analysing dividend stocks.

   However, it’s important to also use historical data when picking your stocks. Past performance is not a guaranteed predictor of future results, but can still be telling. Has the company paid dividends in the past? Have those dividends been consistent and on time? Some companies have what is known as a ‘progressive dividend strategy’, meaning they aim to make each year’s dividend larger than the ones before – is this company one of those?

3. Perform fundamental analysis

   Lastly, don’t forget about fundamental analysis. Carefully research a company’s dividend policies, its future plans and current ventures, sustainability and management structure. All this will help you determine if a dividend stock’s positive yield profile will remain strong in the future.

   Investing in dividend-paying companies is a long-term strategy, so you need to back someone who doesn’t just have a good profile today but will remain a good investment over the years to come.

Learn more about our Smart Portfolio

If you prefer to have dividend stocks picked for you by experts, and your ongoing investments managed by them as well, you can also open a Smart Portfolio

To match you to your best stocks, we’ll ask you to complete an assessment to gauge your risk appetite and suitability. We’ll then recommend a portfolio that consists of a balance of investments, including dividend stocks, to suit your goals and investor preferences.
Once you’ve made your selection from our suggested picks and deposited the necessary funds, our managers will invest on your behalf.
Smart Portfolios are subject to an estimated 0.72% fee on the first £50,000 and 0.22% thereafter.

Open a Smart Portfolio account

How to buy and invest in dividend stocks summed up

• You can invest in dividend stocks – and trade on them too – with us
• Dividend stocks are shares in a company that is known for giving out dividends – payments to shareholders coming out of company profits or retained earnings
• Companies are not obligated to pay out dividends but, if they do, this can be a great form of passive income investing, growth investing or income investing
• You can use some calculations to determine what’s a good dividend stock to invest in, including dividend yields and dividend cover ratio. Equally as important is adequate research and fundamental analysis
• If you’d rather have the stock-picking and managing handled for you, you can also invest in a Smart Portfolio with us

Footnotes:

¹ Our best share dealing commissions apply to clients who opened three or more positions on their share dealing account in the previous month.

² When you receive a dividend payment from us, we’ll also send you a Consolidated Tax Certificate (CTC) which summarises any UK and overseas dividends and interest paid on securities between the dates indicated. The CTC may also be referred to as a Consolidated Tax Voucher (CTV). These are usually generated in May or June, to cover the tax year just ended.

Please note that tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the UK.