I’m looking for part of my Stocks and Shares ISA to provide me with regular and reliable income. Some shares in the FTSE 350 offer whopping yields of up to 35%, but that doesn’t look particularly sustainable to me.
When a dividend yield is so high, it can often be a warning. Earnings may be set to suffer, which would likely mean a dividend cut. Or the yield could look high as a result of a tumbling share price.
Either way, I would avoid these shares. As a guide, I tend to avoid dividend yields over 15%.
The sweet spot
The Bank of England base interest rate is expected to climb towards 4% next year. To compensate me for the additional risk I’m taking by investing in shares, I’d want to earn a greater return than that.
So if I think 4% is too low and 15% is too high, what should I look for? I’d say 6%-10% is my sweet spot.
There are around 40 shares in the FTSE 350 that offer dividends in this range. But I want to narrow this list down further.
The dividend yield isn’t the only factor to consider. I’d want to own shares that are able to sustain these dividends over time too. To determine which stocks have the best chance, I’d look for a few qualities.
Quality dividends
Dividends tend to be paid from earnings. So I’d want to find companies where I think sales and profits will rise. I’d also want to ensure that earnings can sufficiently cover dividends. That’s why I’d look for a dividend cover of at least one.
Dividend stocks tend to be in a more mature phase of their growth cycle. That’s in contrast to faster-growing companies that tend to reinvest all excess cash in growing the business. I find that many of the best dividend shares are ‘large-cap’, stable and established over many years.
A strong dividend history also looks encouraging to me. I find that it often bodes well for future dividend policy too. Bear in mind that much can change in the future, and a business could suffer a fall in earnings. But I’m more comfortable in owning a company that’s focused on returning profits to shareholders in the form of dividend income.
My Stocks and Shares ISA
Now that I’ve determined some criteria, which shares should I add to my Stocks and Shares ISA next?
Right now, I’d buy Aviva, Imperial Brands, Phoenix Group Holdings, Taylor Wimpey and Moneysupermarket.com. With £5,000 to invest, I’d split my investment across all five shares equally.
With this selection, I’d be getting a 7% dividend yield. That’s impressive. On average, brokers forecast a 7% gain in earnings over the coming year too.
With a dividend cover of 1.7 times, and an average dividend history of 19 years, I reckon I’d have a good chance of receiving reliable passive income.
