Many investors buy stocks and shares to create a second income. We can achieve this by buying dividend stocks — companies rewarding shareholders with regular payments — and using the money to help fund our lives.
But in recent weeks, the stock market has pushed downwards, sparked by concern about banks‘ unrealised losses on bonds. So why is this a good time to buy for a second income? Let’s take a closer look.
Buy when others are fearful
Legendary investor Warren Buffett tells us that we should invest when others are fearful. To be precise, he once said it is wise for investors to be “fearful when others are greedy, and greedy when others are fearful.”
Right now, we’re seeing investors and institutions pull back from the market, but that’s not a bad thing because it creates opportunities. With the FTSE 100 down 7% over the month — flat over 12 months — and some banking stocks down 20% over the month, this looks like a great time to buy.
Naturally, it’s always preferable to buy at lower prices even if we are investing for a very long period of time. This allows us to, hopefully, achieve higher returns over the course of the investment.
Dividend yields
Dividend yields fall when share prices go up, and go up when share prices fall — assuming dividend payments remain constant. So in the current environment, I can hope to find inflated dividend yields as share prices fall.
My first point of call is banking stocks, where investors have been most fearful. The thing is, I think this sector pullback is entirely unwarranted. These institutions are performing well, they’re highly regulated, and the quality of their deposits is not problematic.
Let’s take Lloyds which now offers investors a 5% dividend yield after the share price fell 12% over the past month — it’s now down 7% over a year.
The forward yield is very attractive too, with City analysts forecasting a full-year dividend of 2.4p in 2022, rising to 2.7p and 3p in 2023 and 2024 respectively. Using the 2024 dividend forecast, we can assume a forward dividend yield of 6.4%.
It’s also worth noting that these forecast dividend payments would likely be easily affordable if overall performance remains constant, or improves. The dividend coverage ratio in 2021 was 3.8. That means earnings could cover stated dividends 3.8 times — that’s far above the benchmark for a healthy yield of two.
Maximising returns
I’m taking this opportunity to maximise my portfolio’s capacity to deliver a supercharged second income. If I invest in stocks that have fallen 10%, on average, I can essentially create a portfolio that delivers around 10th more in dividends than it would have done a month ago.
As such, I’m also buying more stocks like Hargreaves Lansdown, in addition to banking stocks. Hargreaves has fallen 10%, and now offers a 5% yield.
Of course, there’s no guarantee that the market won’t fall further, but I think valuations are pretty low already right now. For me, now’s a good time to buy.
