With the FTSE 100 hitting a new high in the past week, is there still value to be found in the UK stock market? I think the answer is a resounding yes.
While the lead index may be soaring, some dividend yields from blue-chip firms also remain high. If I wanted to invest £20,000 in a Stocks and Shares ISA right now to target an annual £1,400 stream of dividends, here is how I would do it.
Sticking to quality
Earning that much from a £20,000 investment means I would need to achieve an average dividend yield of 7%.
While 7% may sound like an aggressive target if investing in blue-chip companies, right now quite a few firms offer this level of dividend or better. From British American Tobacco to M&G, I own a variety of FTSE 100 shares in what I regard as quality companies with yields over 7%.
So in investing the Stocks and Shares ISA, I would not be forced to choose between buying into great businesses and earning high yields. In today’s market, I think I can aim to do both at once.
Focus on future cash flow
Hitting my £1,400 target next year could be good. But what about the year after? Or even the following decade?
I would hope to tuck the money away in a Stocks and Shares ISA and then not think about it much while it churns out dividends. I would therefore want to invest in companies I reckon may well be able to throw off huge amounts of excess cash in the coming years.
Cash flow is different to the accounting concept of profit. I look at both, but free cash flow matters because ultimately a company needs cash to pay dividends.
Scope for success
A firm with a competitive advantage in an area likely to see sustained customer demand has a promising basis to generate large cash flows. But other factors matter too. For example, does a large debt pile threaten the dividend (one concern I have about the sustainability of the 8.5% yield at Vodafone)?
So I would invest my Stocks and Shares ISA in firms I thought could generate large future free cash flows and use them to pay dividends. The unexpected can always happen and I would try to reduce my risk by spreading the money evenly across five to 10 companies.
I would also be careful not to concentrate too heavily in a single particular business sector, even though it may have particularly high yields. Insurers such as Legal & General and Phoenix offer juicy yields. But so too did rival Direct Line until it abruptly axed its dividend last month!
Target dividend yield
My key principle would be sticking to quality at an attractive price and never chasing yield for its own sake.
The good thing about an average target yield is that I can invest in firms with a lower yield, as long as my average hits 7% overall.
So, for example, Unilever has the sort of business characteristics I mentioned above – but only a 3.5% yield. It might still earn a place in my Stocks and Shares ISA if I was also investing in shares yielding more than 7%.
