The prospects for many dividend shares may be relatively uncertain after the market crash. In fact, some companies have cancelled their dividends to provide them with greater financial stability in the short run.
However, it’s still possible to build a portfolio of dividend stocks that produces a growing passive income. Through obtaining a wide margin of safety and focusing on a company’s dividend cover, you can select the best stocks to buy right now.
Dividend cover after a market crash
The recent market crash has brought risk more sharply into focus for many investors. After all, the weak global economic outlook may mean that the operating conditions for many businesses come under pressure. This may make it more difficult for them to afford their current level of shareholder payouts.
Therefore, it’s prudent to check the affordability of a company’s dividend before buying it. This can be done through dividing its net profit by dividends paid to provide a dividend cover multiple.
A figure of one means that profits covered dividends once. A higher figure means the company in question had headroom when making shareholder payouts.
Given the uncertain economic outlook and the potential for a second market crash, investors may wish to only purchase stocks that have ample headroom when making their dividend payouts. Otherwise, the chances of a dividend cut may be relatively high should the economic outlook deteriorate further.
Long-term dividend growth potential
As well as assessing the affordability of a company’s dividend after the market crash, understanding its potential to grow shareholder payouts in the long run could be a shrewd move.
It may enable you to not only enjoy a higher income return compared to other assets today, but to obtain an inflation-beating rate of growth in the coming years that boosts your financial outlook.
Assessing a company’s dividend growth potential is, of course, subjective. However, by focusing on its growth strategy, considering the size of its economic moat, and understanding how its operating environment may be impacted by coronavirus, you can paint a picture of its potential for rising profitability and higher dividends.
A margin of safety
While the market crash has caused many dividend stocks to trade at dirt-cheap prices, some companies may merit a low valuation. For example, they may struggle to grow profitability in an uncertain economic period. It may also endure a painful process of changing their business model in response to changing consumer trends.
Therefore, it could be a good idea to demand a wide margin of safety when buying dividend stocks. This may help to reduce your overall risks. It may also improve your long-term total return prospects as the stock market gradually recovers from the challenges it has faced in 2020.
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.