Dividend-paying shares can be a useful way to target passive income through regular shareholder rewards. But the key lesson I learned when first picking stocks to buy is that not every dividend is built to last.
The best income shares are not just those with the highest yields. It’s the ones that can keep paying even when the market takes a tumble.
So how can investors spot reliable dividend shares?
Avoid these three common mistakes
Novice investors often focus on making a quick buck and fail to ask the right questions. That’s one quick way to end up with weak income or, worse, a dividend cut. Make sure to avoid these dividend traps:
- Chasing high yields. A big yield can look exciting, but sometimes it is high because the share price has fallen sharply.
- Ignoring the payout ratio. If a company is handing out too much of its profits, the dividend can become fragile.
- Neglecting diversification. If you own too many income stocks from one sector, a downturn can hit all of them at once.
The clearest example for me was Vodafone. As a company I was very familiar with, I didn’t do sufficient research. Blinded by the high yield, I didn’t check the strength of the dividend properly and soon after buying, it was cut by 50%.
That was a costly reminder that every company, no matter how familiar, requires a closer look. So how can investors identify a sustainable dividend?
How to spot a winner
“The market is often stupid, but you can’t focus on that. Focus on the underlying value of dividends and earnings.” – John C Bogle.
The key metrics you want to focus on are those that indicate long-term dividend sustainability: cash coverage, payout ratio, and historical track record.
I just did a quick screener for those metrics and one stock jumped out at me: Paragon Banking Group (LSE: PAG). Its Q1 FY26 trading update shows lending up 6.9%, along with net loan balances up 3.9% year-on-year to £16.5bn.
Straight off the bat that shows the business is still growing at a decent pace. But more importantly, its dividend credentials are all well above the UK average.
| Metric | Value | UK average |
|---|---|---|
| Dividend yield | 5.9% | 3.1% |
| Payout ratio | 48% (lower is better) | 60% |
| Annualised growth (10y) | 14.84% | 0.73% |
| Cash coverage | 3.42 times | 1.7 times |
Critically, it’s been paying dividends for 31 straight years, which is exactly the kind of record income investors like to see.
Admittedly, the share price has slipped 18.2% in the past year but that’s short-term. Zoom out, and it’s up 52.7% over five years.
So what could go wrong?
Paragon has already set aside £6.5m for the ongoing motor finance scandal, but the final bill remains unclear. If it’s more, profits could take a hit. It already carries £1.71bn in debt against £1.42bn of equity, so the balance sheet is at risk of being stretched.
Even so, the bank is widely regarded as a trusted specialist lender and its income appeal is undeniable.
For a passive income portfolio, I think it’s certainly worth a closer look. But don’t go all in on one stock — there’s a wealth of other excellent dividend stocks I’ve covered recently that are equally worth considering as part of a diversified portoflio.
