How I’d Determine the Best Types of Dividend Stocks to Buy in 2021

Dividend stocks with large competitive advantages and defensive characteristics could be among the best types of income shares to buy in 2021.

man sitting in front of 3 screens programming

Image source: Getty Images

Buying dividend stocks to make a passive income could become increasingly popular in 2021. After all, the income returns of other assets such as cash and bonds are likely to remain disappointing due to low interest rates. Meanwhile, high property prices may restrict their capacity to provide a generous passive income.

Of course, determining what are the best types of dividend shares to buy could be a challenge due to uncertain economic conditions. However, by focusing on competitive advantages, dividend affordability and defensive characteristics, it may be possible to unearth the most attractive income shares for the long run.

Dividend stocks with competitive advantages

Given the uncertain economic outlook, buying dividend stocks that have significant competitive advantages could be a shrewd move. They may be more likely to deliver relatively strong sales and profit during a challenging period for their sector. For example, they may have strong customer loyalty or unique products that allow them to maintain higher margins than are possible among their competitors.

Businesses with significant competitive advantages may also be able to grab market share from weaker sector peers. This may lead to an improving financial performance in the long run that produces a more resilient, and growing, dividend over the coming years.

Defensive characteristics

Dividend stocks with defensive characteristics may provide a more robust income return in 2021. At the present time, it remains unclear how factors such as the coronavirus vaccine will play out. This could mean there is a further period of lockdown measures that lead to poor financial performance from companies that are closely correlated to the prospects for the economy.

As such, buying defensive shares may provide greater security during what could prove to be a challenging year for many industries. In some cases, it is also possible to achieve a high yield from defensive shares. They have not always been popular among investors in recent months because of an increasing focus on growth stocks that are often cyclical in nature. This may provide scope for a higher income return in the coming months.

A low payout ratio

Due to the potential for reduced sales and profitability in the current year, buying dividend stocks that have low payout ratios could be a sound move. A company’s dividend payout ratio can be calculated by dividing its dividend by net profit to give a percentage figure. A payout ratio of less than 100% shows it had headroom when making its most recent dividend payment.

At the present time, it may be prudent to seek companies with a payout ratio of significantly less than 100%. Otherwise, there may be a risk of a dividend cut should their financial performance deteriorate in the short run. Conversely, low payout ratios could mean impressive dividend growth in the coming years that boosts an investor’s passive income.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Dividend Stocks

growing plant shoots on stacked coins
Dividend Stocks

Here Are My Top 5 Dividend Aristocrats to Buy Right Now

Now is the time to buy these top five dividend aristocrats at their two-year low before they recover to 2021…

Read more »

edit Real Estate Investment Trust REIT on double exsposure business background.
Dividend Stocks

Is NorthWest REIT Stock the Best High-Yield Dividend for You?

NorthWest REIT (TSX:NWH.UN) offers a substantial dividend, but exercise caution with this riskier stock.

Read more »

STACKED COINS DEPICTING MONEY GROWTH
Dividend Stocks

Income Stocks: A Once-in-a-Decade Chance to Get Rich

These two income stocks are among the best on the TSX for those seeking consistent total returns over a long-term…

Read more »

dividends grow over time
Dividend Stocks

3 Top Royalty Stocks With Dividend Yields of up to 9%

When it comes to secured dividends, these three are top notch. Each offers exposure to royalties through franchising and ultra-high…

Read more »

Golden crown on a red velvet background
Dividend Stocks

This 8 Percent Dividend King Pays Out Every Month

Canoe EIT Income Fund (TSX:EIT.UN) is a staple for monthly income investors.

Read more »

sad concerned deep in thought
Dividend Stocks

Should You Buy Fortis or TC Energy Today?

These stocks have great track records of dividend growth.

Read more »

Dice engraved with the words buy and sell
Dividend Stocks

A&W Stock: Buy, Sell, or Hold?

Shares of A&W (TSX:AW.UN) stock popped by 20% after a major corporate restructuring announcement investors love.

Read more »

Payday ringed on a calendar
Dividend Stocks

3 Monthly Paying Dividend Stocks With Handsome 7% Dividend Yields

Given their healthy cash flows and high yields, I am bullish on these three monthly-paying dividend stocks.

Read more »