While generating significant amounts of capital growth is hugely satisfying for any investor, so too is obtaining a second income in the form of high and consistent dividends. Not only could a generous second income help afford a better lifestyle in the short run, it could also lay the foundation for a bright future when it comes to retirement. It could even bring the latter a step closer.
However, there’s much more to obtaining a second income stream than simply buying high-yield shares. Here are some key factors which could have an impact upon your ability to generate an impressive dividend income stream.
Management attitude
While the financial performance has a major impact on a company’s ability to pay a rising dividend, so too does the attitude of its management towards rewarding shareholders. Some management teams will take the decision to pay out a generous proportion of profit as a dividend each year, with this level rising in line with profit growth. This may be because they are relatively upbeat about the long term outlook and doesn’t necessarily require large cash balances in case of financial need.
However, there are other management teams which may be more ambitious when it comes to growing the company in question. They may utilise a significant portion of cash flow to make acquisitions, or to reinvest for future growth. While such moves may improve future total returns, they could also harm dividend prospects in the near term. Therefore, listening to management’s plans regarding future dividend payments and policies could be a worthwhile step for investors to take.
Maturity v start-up
The age of a company also has a significant bearing on its dividend prospects. A stock that has been in existence for a long period of time may not have the same level of growth potential as a start-up. It may therefore generate excess cash above and beyond the amount that it required for replacement capital expenditure.
This situation lends itself to a higher dividend, as well as greater consistency. In other words, a mature company is more likely to be in a dominant position within its industry. This could mean a larger amount of resilience when it comes to dividend growth. In contrast, a younger company may require all of its profit to be reinvested in order to take advantage of growth opportunities.
Sector choice
Clearly, some sectors are more likely to generate a high and consistent income stream for investors than others. While history is never perfectly repeated in investing some sectors, such as utilities, tobacco and consumer goods, have historically generated reliable dividend growth. In future, there will undoubtedly be changes in all three industries, with regulatory change likely to affect utility and tobacco stocks for example. Similarly, the consumer goods industry is also changing as demand from emerging markets continues to outstrip those found in developed economies.
However, by focusing on sectors that have historically been sound places to invest from an income perspective, it may be possible to generate a surprisingly high second income. When added to stocks that are mature and which have management teams focused on returning cash to shareholders, in the long run your second income could amount to much more than you currently expect.
