2 cheap UK shares I bought for extra passive income

Last week, I bought these two UK shares after their stock prices dropped. One now offers a dividend yield of almost 11% a year and the other is nearly 13%!

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Over the past four weeks, I’ve been a busy little bee. I’ve been investing a lump of spare cash in cheap UK shares. Starting on 29 June, my wife has bought 10 new stocks in a new mini-portfolio for our family’s future. How exciting, right?

Two cheap UK shares we bought for fat dividends

Here are two stocks we bought for their market-beating dividend yields. All being well, we intend to hold these for many, many years, collecting passive income as we go.

#1: Direct Line

Direct Line Insurance Group (LSE: DLG) has been selling insurance in the UK since 1985, using its familiar logo of a red telephone on wheels. Beginning by offering motor insurance, it has expanded into selling life, pet, travel and business insurance.

Before Covid-19 crashed markets in March 2020, Direct Line shares were trading at around 350p in mid-February 2020. Today, they sit almost 40% lower, as shown by these fundamentals:

Share price*209p
52-week high319.4p
52-week low184.55p
12-month change-29.8%
Market value£2.7bn
Price/earnings ratio8.7
Earnings yield11.5%
Dividend yield10.9%
Dividend cover1.1
*As of close of business on Friday, 29 July

Direct Line stock has dived 17% over the past month, so we swooped in to buy these cheap shares. They currently offer a huge dividend yield of almost 11% a year, but this is only just covered by earnings. And while insurers’ profits are under pressure this year, the group has said this bumper dividend is safe for now. I’ve no doubt that this FTSE 250 firm will have a tough 2022-23, but I expect things to improve after then. That’s why we’ve bought it as a long-term hold for dividend income and capital gains.

#2: Persimmon

We bought shares in Persimmon (LSE: PSN) at the beginning of last week. This FTSE 100 company is one of the UK’s biggest housebuilders. But why are we buying into a property company as interest rates start rising and house-price growth starts cooling? Simply because I view these shares as too cheap, based on their modest fundamentals:

Share price*1,884p
52-week high2,974p
52-week low1,717.5p
12-month change-35.6%
Market value£6bn
Price/earnings ratio7.7
Earnings yield13.1%
Dividend yield12.5%
Dividend cover1.0
*As of close of business on Friday, 29 July

Persimmon stock trades on a price-to-earnings ratio below eight and offers a whopping dividend yield of 12.5% a year. But this leaves its cash dividend barely covered by earnings, so I fully expect this double-digit cash yield to come down in time. Yet such a massive passive income is too tempting for me to resist right now.

Sadly, dividends aren’t guaranteed

Now for the bad news. UK share dividends aren’t guaranteed, so future payouts can be cut or cancelled completely. Indeed, history has taught me that double-digit dividends are rarely sustainable.

But even if the above dividend yields were to be halved, they would still be well ahead of the FTSE 100’s cash yield of around 4.1% a year. And that’s why I will keep buying cheap UK shares for extra passive income, despite my worries about inflation, interest rates, economic growth, and the war for Ukraine!

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Cliffdarcy has an economic interest in Direct Line Insurance Group and Persimmon shares. The Motley Fool UK has no position in any of the shares mentioned. 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.

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