How to enjoy the dividend revival

By Ian Lyall for MailOnline
Updated: 06:48 EDT, 16 May 2011

Dividends are back in fashion. According to the latest data from Capita Registrars, which keeps a tab on these things, Britain's quoted companies are on target to return around £65bn this year, a rise of almost 8%.

Money spinner: Impact of dividends on increasing investment returns should never be underestimated

Investment bank Citigroup says businesses are now running down the cash they squirrelled away during the financial crisis - and they are giving some of it back to investors.

This change in corporate strategy coincides with an increase in demand for shares, particularly income-bearing stocks, as paltry savings rates have finally pressed investors to take more risks.

So how do you spot the top dividend plays? The stock market prices pages of the Daily Mail, Times and Financial Times are a good place to start.

A column to the right of the share price will give you the dividend yield - which is simply the dividend expressed as a percentage of the share price.

The higher the yield, the better the payout - or at least that's the logic. However, an anomalously high yield - perhaps in double digits - may be the result of a tumbling share price, and not a generous dividend policy. So beware.

There is also a problem with taking the dividend yield printed in the paper - it is an historic figure. What you really want to know is how much the company plans to pay its investors this year, not what it paid last year.

There are a number of online resources that will help you find the forecast dividend yield. I used a free service called Digitallook (www.digitallook.com) which has stock screener that allows you to rank shares from high to low based on the company's expected dividend payout.

The FTSE 100's most prolific payers are the insurers RSA, Standard Life, Aviva and Resolution which each have a predicted dividend yield of more than 6%, and in the case of RSA closer to 7%.

In the FTSE 250 Cable & Wireless Communications and Cable & Wireless Worldwide are the top payers. However, there is more to picking income stocks than juicy dividend yields, according to Daniel Harris, the head of trading at H2O Markets.

'A lot of other factors need to be taken into the mix such as the sustainability of the dividend and indeed, how the dividend is financed,' he says.

Look for companies that have a track record for earnings and dividend growth, and avoid heavily indebted firms, Harris advises. Even after this thorough sifting process, there are plenty of income stocks to consider. Investors might look at some of our larger companies exposed to the tiger economies of Asia or fast-growing Latin American nations. And there are of course the bargain buys: the cash cows such as GlaxoSmithKline and AstraZeneca, which trade on low price to earnings ratios yet still yield upwards of 5%.

Then there are the so-called defensives which will be largely unaffected by the difficult economic backdrop both here and in Europe and the US. The drug stocks fall into that category too, as do shares in Britain's supermarket chains and the major utilities.

There are two points to bear in mind when buying stock in the quoted power and water companies. They are heavily regulated, so the dividend tap could be turned off at any time. Also, most of the utilities carry high levels of debt, which means they are not quite the safe havens many believe.

The impact of dividends on investment returns should not be underestimated, particularly if the income is reinvested rather than spent.

Let me give you an example of what I mean. £10,000 invested 20 years ago might be worth £27,500 today including dividends and assuming a very low capital growth rate. However, reinvesting the dividend - buying more shares with the dividend cash rather than simply banking it - would have turned that initial £10,000 into £40,000 over two decades.

If you want to follow this strategy then you will need a dividend reinvestment plan, also known as a Drip. Many of the FTSE 100 companies operate them as do share registrars such as Capita and Equiniti.

The system works by lumping all the similar share purchases together, meaning trading costs are minimal on such a deal. The downside, however, is you don't really get a say as to when the shares are bought.