After 2020’s dividend drought, this year has been good for earning a passive income. Many FTSE 100 companies have restarted dividends. And going by the economic outlook for next year, it appears that dividends will stay strong in 2022 too.
So it is a good time for me to start planning my next set income investments. But when I am spoiled for choice among FTSE 100 stocks, I need to take special care as to which stocks to buy. As a guide, I look at a few indicators to understand the long-term potential of the company to help me earn a passive income.
Profits and dividend cover are important
The first is profits. A loss-making company that also pays dividends is a no-go for me. It means that the company cannot afford them. While it is essential that the company make profits, it is also important that it is able to sustain the dividends. This brings me to the dividend cover, which is the net profits divided by dividends. If the cover is one, then the company can just about pay dividends. Ideally, I like the stocks I buy to have a cover higher than that. Two is widely considered to be a good cover.
FTSE 100 dividend sustainability
It can happen though, that for reasons outside its control, a company’s profits can dwindle in one year, reducing its cover. So to get a better understanding, I look at past dividend trends. A number of FTSE 100 stocks have paid dividends pretty much through the past decades, which gives me confidence that the company under consideration has a dividend policy in place.
The all important dividend yield
Importantly, I also look at the dividend yield, which is the dividend amount expressed as a percentage of the share price. It tells me what the return on my investment can be. Though for long-term investing, I would also consider dividend growth, along with yield. If a stock’s price is rising fast, its yield may not look that appealing at first glance. But if it has a high dividend growth as well, then over time the yield on my initial investment can still look sky-high.
1 FTSE 100 stock I like
Based on these criteria, one FTSE 100 stock I like is National Grid. It is profitable, with a dividend yield of 5.2%, which is higher than that paid by the average FTSE 100 stock. Unlike many other companies, it has not cut dividends even once during the past decade. It has also grown its dividends by 3.1% every year over the past decade, which is higher than the typical inflation rate. Further, it also has a dividend cover of 1.3 times, which is not ideal but close to adequate.
National Grid could look less attractive next year, considering that its dividends are expected to grow by 2% according to AJ Bell data, which is lower than the expected inflation rate of 4%. If so, my real dividend yield would reduce. But over the long term, I think this is a winning income stock to buy for my portfolio.
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Manika Premsingh has no position in any of the shares mentioned. The Motley Fool UK has recommended National Grid. 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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