As a value investor, my goal is to buy and hold cheap shares in quality companies for the long term. But one joy of being a shareholder is collecting passive income in the form of dividends. And over the years, this extra income has become increasingly important to my family.
Income from share dividends
I don’t own any bonds (corporate or government), nor do I own any investment property. In fact, I rely on dividend-paying shares for pretty much all of my passive income. But my first problem is that not all listed shares pay dividends. Indeed, most London-listed stocks don’t pay cash dividends to shareholders.
My second problem is that future dividends are not guaranteed. This means they can be cut or cancelled at any time. Thus, share dividends are riskier (and more volatile) than, say, saving interest or bond interest coupons. Then again, the increased risk of investing in shares for income has produced superior returns for me over time.
Three FTSE 100 shares with delicious dividends
By the way, what I look for are shares with low price-to-earnings ratios/high earnings yields, high dividend yields and dividend cover well above one. As an example of the sort of shares I look to for dividend income, here are three FTSE 100 stocks that fit my bill.
| Company | Legal & General | M&G | Rio Tinto |
| Business | Asset management | Asset management | Mining |
| Share price | 256.2p | 187.6p | 5,687p |
| 52-week high | 309.9p | 230p | 6,343p |
| 52-week low | 201.4p | 159.3p | 4,424.5p |
| 12-month change | -11.5% | -4.7% | +23.8% |
| Market value | £15.3bn | £4.4bn | £94.3bn |
| Price-to-earnings ratio | 7.5 | – | 6.4 |
| Earnings yield | 13.3% | – | 15.5% |
| Dividend yield | 9.3% | 9.8% | 9.3% |
| Dividend cover | 1.4 | – | 1.7 |
Two of these shares — Legal & General Group and Rio Tinto — absolutely fall within my definition of value stocks. The other (M&G) offers a near-10% dividend yield, but this is not covered by the asset manager’s trailing earnings. That said, the group’s earnings are expected to return to normal levels in 2023 and should cover the next round of cash payouts.
My family portfolio has already bought two of these stocks for their ability to generate passive income. For the record, my wife bought into Rio Tinto and L&G in late June and early July, respectively. I’m optimistic that both companies will reward us with solid cash dividends over the years ahead. Also, though we don’t own M&G stock at present, it is on my watchlist of future buys.
A 9.5% dividend yield
Were I to invest the same amount into each of these income shares today, then the average cash yield across all three stocks would be a handsome 9.5% a year. However, I’d never build a portfolio out of just three shares, because it would be too concentrated and risky. A more balanced portfolio would include, say 20+ stocks. And that’s what we’re building this year.
Finally, I suspect that next year will be tough for UK corporate revenues, earnings and cash flow. After all, we face an unprecedented cost-of-living crisis triggered by soaring inflation and sky-high energy bills. Nevertheless, I’d happily buy these shares today for their potential capital gains and long-term passive income!
