With the mini market crash that we’re seeing at the moment, some investors are likely wondering what the next few months holds for the UK stock market. Of course, there’s going to be uncertainty, but if we do continue to see the market fall lower, I don’t see this as the end of the world. One reason for this is that a crash will enable me to actually increase the levels of passive income that I get from dividend stocks.
Lower prices boosting the dividend yield
The main way that I judge the level of passive income that I get from a stock is by looking at the dividend yield. This is a calculation that considers the dividend per share in relation to the current share price. The higher the dividend per share is versus the share price, the higher the overall yield will be. It’s also true that the lower the share price is, the higher the yield becomes.
Putting this together, what happens if we see a full blown market crash? The share prices of many stocks are likely to fall. One impact of this is that the dividend yield will increase. For example, let’s say stock X has a price of 100p at the moment, with a dividend per share of 10p. The dividend yield is 10%. If the share price falls to 80p, the dividend yield has increased to 12.5%.
So if I’ve got my eye on some dividend shares for passive income, a market crash could allow me to boost my overall yield. Buying shares during the market crash allows me to pick up the stock at lower prices. Clearly, I don’t know where the bottom of the market will be. Yet if I have a target level of income that requires a target yield, as long as this is met, then I should be happy.
Passive income risk via dividend cuts
There’s one large risk in this process that I do need to be aware of. Sometimes, the market crash will cause a share price to fall for a good reason. It might be that the new Covid-19 variant will hinder the business from operating, reducing profits. This might make the board cut the dividend per share in 2022. This would reduce my dividend yield as a result.
However, this just means that I need to be smart in the dividend shares I pick for passive income. A market crash will cause even good companies to take a hit to their share prices. Even if the business operations won’t be hampered, the share price could still fall due to investor fears. These are the opportunities that I can jump on. If I’m confident that the profitability of the business won’t be hurt (I can check performance from 2020), then the dividend is likely to be safe.
Overall, a market crash can be an opportunity for me to maximise my dividend yields.
Jon Smith and The Motley Fool UK have 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.
This post was originally published on Motley Fool
