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After 35 years of buying shares, my investment strategy is fairly well-honed. I’m an old-school value investor, so I buy companies whose share prices I think are trading below fair value. Also, I’m drawn to buy dividend shares — stocks that make regular cash payments to shareholders — for their passive income.
One problem with dividend shares
Ideally, I like to buy ‘cheap’ shares in solid companies trading on low price-to-earnings ratios and correspondingly high earnings yields. In addition, I hunt down dividend shares that offer market-beating cash yields to patient shareholders. Alas, the problem with being a value/income investor is that not all shares pay dividends.
Indeed, the majority of stocks listed in London don’t pay regular cash dividends. Also, future dividends are not guaranteed, so they can be cut or cancelled anytime. For example, many UK-listed businesses slashed or deferred their dividends during 2020’s Covid-19 crisis. However, many then restored these payouts as the world returned to normal.
FTSE 100 dividend shares
The good news for me is that almost all companies in the UK’s blue-chip FTSE 100 index do pay out dividends. Right now, the Footsie offers a dividend yield of around 3.8% a year. Then again, many Footsie members offer far higher cash yields, such as these three ‘dividend dynamos’:
Three dividend dynamos
My table shows that shares in housebuilder Persimmon have crashed by more than half over 12 months. This has driven up its dividend yield to almost 18% a year — surely an unsustainable level? Furthermore, this dividend is not covered by trailing earnings, a sign to me that this payment is sure to be slashed in 2023. However, my wife owns Persimmon shares and plans to hold onto them for their long-term recovery potential.
We also own shares in Anglo-Australian mega-miner Rio Tinto, which currently offers a near-double-digit dividend yield. But this cash payout is covered 1.7 times by trailing earnings — a much higher margin of safety than that for Persimmon. That said, Rio Tinto’s 2023 earnings might be hit by falling metals prices or waning Chinese demand. Also, it last cut its dividend in 2016, so it has prior form in this field.
Finally, shares in asset manager M&G also offer a market-beating dividend yield of 9.5% a year. However, this is not covered at all by current earnings (though M&G’s profits are expected to rebound in 2023). On the other hand, the group’s future is closely tied to the performance of global asset prices, which may weaken again next year. So M&G’s dividend is by no means guaranteed looking ahead.
I like Rio best
Summing up, I’m expecting a UK economic recession next year, which will hit company earnings and may place some dividends under threat. But of the three dividend shares above, I favour Rio Tinto for its massive cash flow, earnings, share buybacks, and ongoing cash returns. And that’s why we’ll hold onto our Rio Tinto shares for dear life!