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3 dividend stocks to add income to a portfolio

We look at 3 potential dividend shares for income.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

There are two ways to make money holding shares – selling them when the price goes up or collecting dividends. In an ideal world, a stock would offer both growth and income with a rising share price and a constant stream of dividend payments. But in practice it's a rarity.

Dividend-paying companies share a portion of any profits with investors through dividend payments. The more reliable their dividend, the more investors are typically willing to pay for them. However, no dividend is ever guaranteed.

What makes a good dividend?

Dividends can be expressed in absolute terms, 4p per share, or as a percentage of the share price as a yield. The latter is a more useful way to compare dividends. That's because a 4p dividend from a stock that costs £4 yields one percent, but a 4p dividend from a stock that costs 40p offers a 10% yield.

You can't just search for the highest yields in the market and call it a day, though. The yield is sensitive to the share price – so a stock whose share price has fallen considerably will have a higher yield than one that's risen. If the depressed share price is the result of underlying weakness in the business, chances are that dividend won't be around much longer.

Dividend coverage

For that reason, dividend investors often use a dividend coverage ratio (dividend cover) to determine whether or not a company has the means to keep up its dividend.

This coverage ratio tells you how many times a company can pay its dividend using its profits. A coverage ratio of 1 means the company is paying out all of its profits. That could indicate that the company isn't investing at all (or at least very little) in future growth. While dividends are a good way to profit from your investments, they shouldn't come at the expense of the company's long-term future. Generally speaking, a coverage ratio of 1.5 indicates a sustainable dividend.

All the information you need to find out about dividends is available in a company's annual report. But if you don't want to do all the legwork, we monitor over 100 stocks and provide relevant, digestible updates to help you make more informed investment decisions.

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With that in mind, here's a look at a few of what we feel are the market's better positioned dividend stocks.

This article isn't personal advice. All investments and any income they produce can rise and fall in value, so you could get back less than you invest. Yields will vary, they aren't guaranteed and past income isn't a guide to the income you'll receive in future. Ratios and figures shouldn't be looked at in isolation. If you're not sure if an investment is right for you, ask for financial advice.

Investing in individual companies isn't right for everyone – it's higher risk as your investment is dependent on the fate of that company. If a company fails you risk losing your whole investment. You should make sure you understand the companies you're investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Verizon

Telecoms are notoriously dividend friendly – most of the sector's big names pay a dividend. But while yields are plentiful, the fast-changing landscape means profits are a bit harder to come by. For that reason, a coverage ratio above 1 is above average for this sector.

Chart showing comparative dividend yield and dividend cover for telecoms stocks

Yields are variable and not guaranteed. Source: Refinitiv, 25/05/21.

Verizon's prospective yield of 4.5% might not look like much compared to peers like Vodafone, which boasts a dividend yield over 6%, but there's something to be said for security – particularly when it comes to income investing.

Competing in the telecoms space is no easy task – there's not a ton of differentiation between providers, so it often comes down to prices. This is good for consumers, but not so good for margins. Verizon is in pretty good financial shape, though. Free cash flow has risen considerably over the past few years and profits before tax have been steadily creeping upward over the past three years.

The rollout of 5G should add to Verizon's value proposition as well – a faster, more expansive network means demand for connectivity. But it's an expensive undertaking that added over $40bn to the group's net debt (readily available assets minus debt) position last quarter.

Spending big to ensure a place in the government's electromagnetic spectrum is a necessary evil to compete in the next phase of the world's transition online, though. So far Verizon appears willing and able to balance spending needs with investor returns with a coverage ratio of 1.8.

See the latest Verizon share price, charts and how to trade

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Imperial Brands

Another place income investors often find themselves fishing for dividends is in the tobacco sector. The companies in this segment are in a unique position. On one hand, the declining number of smokers is shrinking their addressable market. But smokers have historically stomached price increases without batting an eye. That's helped the industry's biggest players continuously grow their dividends.

Despite cutting its dividend to focus on reducing how much debt the group had last year, Imperial Brands still offers the highest prospective yield in the group. Its dividend coverage ratio of 1.9 is also at the top of the pack.

Chart showing comparative dividend yield and dividend cover for tobacco stocks

Yields are variable and not guaranteed. Source: Refinitiv, 25/05/21.

In the medium-term, tobacco companies are likely to continue plodding along as they always have – raising prices to protect profits. But the ever-shrinking pool of smokers only has so much to offer. At some point they'll need to pivot toward a trend with some growth behind it. For Imperial, that means distribution or next generation products like vape pens and heated tobacco. We're not overly impressed by either part of the group's business so far – though distribution's wading into the pharmaceutical space, which could have promise.

We might never see smoking disappear completely, and the industry's decline is proving to be more of a slow burn than a sudden explosion. That gives Imperial some time to develop new growth avenues while keeping its profits, and by proxy, dividends, ticking over.

See the latest Imperial Brands share price, charts and how to trade

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Polymetal International

Dividends are a key reason some people invest in miners. The sector is often weighed down by environmental concerns, so some institutional investors like fund managers and pension groups can't, or won't, invest. Plus, growth in this sector comes at a high cost – opening a new mine is expensive and needs lots of investment. That means dividends make up a large portion of the investment case.

Chart showing comparative dividend yield and dividend cover for mining stocks

Yields are variable and not guaranteed. Source: Refinitiv, 25/05/21.

Rio Tinto has the highest prospective yield, but Polymetal International's respectable 6.9% comes with 1.8 times dividend coverage. Polymetal's above-average dividend is a recent development. Based on a strong performance in 2020, management upped its dividend payments by 57% at the end of the year.

Anytime a company increases its dividend payments, it pays to consider what that means for the coverage ratio. If the increase is based on sustainable, improved performance, it shouldn't bring the pay out into worrisome territory. That's the case for Polymetal – after the hike, the group's dividend coverage ratio is still just shy of 2.

Polymetal mines precious metals, with gold bringing in the majority of the group's revenue. That makes Polymetal somewhat defensive if the rest of the market is in decline, as investors tend to flock to gold in times of uncertainty.

We should flag that Polymetal makes its money in US dollars, but its costs are charged in the Russian rouble. That creates a currency risk for the company that's closely tied to oil prices (the rouble's performance is linked), which are likely to be volatile for some time.

However, cash flow has never been an issue for Polymetal. We're encouraged by the group's efforts to lower its net debt position, which will make absorbing any currency shocks easier.

See the latest Polymetal International share price, charts and how to trade

The bottom line on dividends

Just as you can't judge a book by its cover, you've got to look under the hood when it comes to dividend stocks. While price performance isn't as important when you're buying a dividend stock, the company's underlying long-term health is crucial.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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