Buying shares in successful companies that pay dividends can be a good way to earn some extra income. Here is how I would take advantage of recent stock market turbulence to invest £3,000, with the aim of earning £250 in dividends annually.
Why now?
In recent days, the prices of some leading blue-chip shares have fallen.
When a company pays dividends, as its share price falls the dividend yield increases. The average yield of the shares I buy is what determines how much money I ought to earn each year if I invest £3,000.
Right now, some yields look attractive to me. But I never buy dividend shares just because of their yield. I aim to buy high-quality businesses selling at attractive prices. In the current market, although some tempting yields are on offer, I think it can be hard to know what the prospects are for some businesses. So I would focus on firms I think can continue to do well, even if the economy gets worse.
Dividend shares and income generation
Many investors try to decide whether growth or income shares might suit their objectives better.
The split is not always clear though. Companies like Diageo and DCC have both income and growth prospects, in my view.
Some companies look to me like they have limited long-term growth potential. By ploughing a lot of their free cash flows into paying dividends, such firms can make attractive income picks for my portfolio.
Finding shares to buy
An example of such a company is British American Tobacco. Its pricing power and move into non-cigarette product lines does mean the company may keep growing, but I see its core market of cigarettes as being in long-term decline.
For me, the attraction of this share is primarily its income prospects. I think the firm may generate strong free cash flows for decades yet. It has a 7.5% dividend yield. I also own US rival Altria, with an 8.2% yield.
I am wary of bank shares right now, but I think asset management and insurance firms can do well over the medium- to long-term in aggregate, even if some fare poorly. M&G offers an 11% yield, Legal & General offers 8.5% and Abrdn is on 7.2%.
To hit my target of £250 per year from a £3,000 investment, I need to achieve an average yield of around 8.3%. That is an average, so I can buy some shares with a lower yield if other shares raise the average to what I want.
Whatever dividend shares I decide to buy, as always, I would diversify between companies and indeed business sectors. So £3,000 is ample to do that, putting £500 into each of six different listed businesses, for example.
Buy-and-hold
With a clear objective of income, I would take a buy-and-hold approach.
I would occasionally check to see whether anything had happened that might change my investment thesis about a company. For example, could a likely change in profitability threaten the dividend? Has the long-term outlook for customer demand changed dramatically?
Beyond that though, I would be happy to let my portfolio of carefully chosen blue-chip dividend shares tick over, hopefully earning me passive income on an ongoing basis.
