It’s often thought that dividend shares are exclusively established and slow-growth companies. And quite often they are just that. But why should I settle for companies that grow slowly when there are faster-growing shares available that also pay dividends?
I reckon I can have my cake and eat it, capturing both a decent dividend yield and earnings growth. By doing so I can hopefully make some capital gains over time in addition to some yearly income.
Picking the best dividend shares
Quite often, history can give a guide to what I can expect. Now, I must include a caveat here. History doesn’t predict the future. But with some of the more mature, established and stable companies, it might provide some clues.
I’ve got some criteria to narrow down my search for the best dividend shares that also have growth potential. The average dividend yield for the FTSE 100 is currently 3.4% so I’m looking for shares that yield above this figure. I like consistency, so I’m looking for companies that have been paying regular dividends for at least 10 years. For growth, I’d like to see three things. Firstly, I want double-digit annual earnings growth for the past five years. Secondly, I’d aim for positive forecast earnings growth for the upcoming year. Some indication that earnings could rise might give me some confidence. Finally, I’d like to see some share price momentum. For instance, it would be nice to see share price gains of over 5% per year over the past half-decade.
Top picks
Several companies match my criteria but I’ll focus on the top three that I’m considering for my Stocks and Shares ISA now. If I was investing £5,000 today, I’d split it between these three top picks. Mining giant BHP Group currently offers a 10% dividend yield. That’s far above average and normally I would have some suspicions on whether that level of yield can be sustained. However, BHP has over a 20 years history of paying dividends. Its share price has also gained by 8% per year over the past five years. To top it off, annual earnings growth for the last five years is a whopping 66%.
Another mining giant Rio Tinto fulfils similar criteria. With over a decade of dividend-paying history and a generally upward trending share price, I like what I see. I’d say that its profit margin of almost 50% is equally impressive, as well as its 11% dividend yield. In fact, including special dividends, its dividend yield jumps to an even more impressive 15%.
Next, I’m considering Jarvis Securities. With a market capitalisation of just £122m, it’s far smaller than my other two picks. However, what it lacks in size, it makes up in potential. Long-term shareholders have been rewarded with a 30% annual share price return over the past five years. I’d expect earnings and the share price to grow further. Currently the shares offer a 4% dividend yield. It’s much lower than Rio and BHP but I reckon it offers greater growth potential to make up for it.
A word of warning, however. Earnings can fall for a number of reasons. And a significant drop in earnings can force a company to suspend its dividend payments. This was a common occurrence during the Covid crash in March 2020. That said, by holding a basket of diversified dividend shares I hope to lower my risk.
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Harshil Patel has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.
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