We’d all love to have a second income. In fact, it’s the reason many of us invest in stocks. We buy shares in companies that reward shareholders with regular, albeit not guaranteed, dividends.
But why do I think now is such a great time to buy stocks for a second income? Well, it’s all down to depressed share prices and higher yields.
Investing for dividends
When I invest for dividends, it’s all about the yields. Lots of companies pay a dividend, but some are negligible. What I want is the biggest sustainable yields on the market.
Right now, I think the largest ‘safe’ yields are around 8%. That’s huge. But I have to be careful. I’ve really got to do my research to assess whether these yields are affordable. There’s no guaranteed a dividend will be paid. It could be cut or cancelled at any time.
Sustainability
The first place to look to see if a company has a sustainable dividend yield is the dividend coverage ratio (DCR). This tells us how many times a company can pay its dividends from its earnings over a year. Typically, a DCR of two and above is considered healthy.
But cash generation is another factor. Some companies have very strong and stable incomes. This, in theory, gives their dividends greater stability, because they should have the cash on hand to pay the dividend. Some companies earn money in more sporadic bursts.
Forward yield
I’ve also got to be looking forward and asking the right questions. Is there room to grow the dividend? Does the company have a track record for increasing the dividend year after year?
For example, Barclays offers an above-average 4.6% dividend yield. And in 2022, the dividend was covered by income 4.25 times. Analysts are now forecasting the dividend being lifted further, and this would take the forward yield to 5.5% and 6.2% for 2023 and 2024 respectively.
But with the dividend covered 4.25 times, it’s plausible to see further dividend rises. This could be one of the biggest forward dividends on the index.
Why now?
Naturally, if we have a lot of capital, it’s easy to generate a sizeable second income. If we put £200k in stocks averaging an 6% yield, we can earn £12k a year. It would be tax-free if all this money was in an ISA too. But if I don’t have that amount of capital, it may pay me to practice a compound returns strategy, using big dividends to grow my portfolio.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
But what makes now a good time to invest? Well, simply, it’s because share prices are depressed. The FTSE 350 is down 2% over five years. And share prices in several sectors, such as housebuilding and banking, have suffered this year — unfairly, in my opinion.
As such, I see a rare chance to buy great stocks like the aforementioned Barclays as well as companies like Phoenix Group and Vistry — which have 9% and 7.5% yields respectively — while share prices are low, and dividend yields are high. This is all possible because dividend yields and share prices are inversely correlated.
These are the dividends to supercharge my second income generation. But there are other great stocks to choose from.
