One of the rewarding things about owning shares can be the payments I receive as a shareholder. Not all shares pay dividends, but many do – and they can add up.
If I had a spare £1,000 to invest in dividend shares and wanted to target an annual yield of 7%, here is how I would go about it.
Looking for robust businesses
Earning dividends next year would be good. But as a long-term investor, my field of vision is much bigger than that. I would like to find dividend shares that hopefully pay out for many years to come. As dividends are never guaranteed though, what should I look for?
To begin, I would consider areas where I expect there to be robust customer demand. From electricity generation and distribution to shampoo sales, I see many such fields. I do not fully understand all of them though, which can make assessing commercial prospects challenging. So I focus on areas I do understand.
Next, I would look for companies within those areas that have a competitive advantage. That gives them pricing power, something that can help power future profits – and dividends. For example, in the area of electricity distribution, the network owned by National Grid is one of a kind.
Valuation matters
But simply finding a good business I think could pay beefy dividends is not enough. Valuation also matters. If I overpay for shares, even if they offer good dividends, I may end up in the red overall due to a falling share price.
So I would look for dividend shares that have a compelling investment case but sell at what I think is an attractive price. For my portfolio, that rules out shares like Judges Scientific. I think it is a great business – and has been a steady dividend raiser, but the valuation looks too high for my tastes, with a price-to-earnings ratio over 50.
The role of yield
Even if Judges was trading at an attractive valuation, it would not be among the dividend shares I would buy to target a 7% yield. It yields less than 1%.
My target of 7% is only an average, so I could invest in shares with a range of yields. But a very low yield like the one offered at Judges would not make the cut. However, as I explained above, I would not start with yield. Instead I would focus on finding the right sorts of companies with attractive valuations. Only then would I consider their yield.
I think a 7% average yield from quality companies is possible. I currently own blue-chip FTSE 100 shares with a higher yield than that, such as M&G.
Buying a range of dividend shares
However, I would want to reduce my risk by diversifying across a range of dividend shares. £1,000 may not sound like a lot of money for this – but I think it is enough.
I could split it evenly across two, three, or four different companies, for example. By spreading my money over a range of promising shares, I believe I would have a high chance of hitting my target dividend yield.
The post Here’s how I’d invest £1,000 in dividend shares to target a 7% yield appeared first on The Motley Fool UK.
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C Ruane has positions in M&G Plc. The Motley Fool UK has recommended Judges Scientific Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.