Three key factors are crucial to me in finding stocks suitable to generate a healthy, sustained second income. They are a history of paying high dividends, balance sheet strength and a low price relative to their recent range.
From the middle of Q1, several stocks were discounted in the London Stock Exchange’s (LSE) financial services sector.
This resulted from fears of another financial crisis, sparked by the failures of Silicon Valley Bank and Credit Suisse, in my view.
But this looked unwarranted to me. New rules to strengthen UK financial firms’ balance sheets came in after the Great Financial Crisis.
There is a risk, of course, that the cost-of-living crisis could deter new client business for all financial services companies.
Nonetheless, two stocks especially caught my eye to generate a healthy second income.
Legal & General
Legal & General (LSE: LGEN) is down 15% from its 7 March high this year, which ticks one box for me.
Its Solvency II ratio — measuring shareholder protection against a company becoming insolvent — rose to 236% in 2022. This compares to the 100% ratio that meets the statutory requirements for UK insurance companies. This ticks another box for me.
In terms of dividends, it paid out 16.42p per share in 2018 — a yield of 7.1%. In 2019, it paid 17.57p (5.8%), the same again in 2020 (6.6%), and 18.45p in 2021 (6.2%).
In 2022, the payout was 19.37p, which on the current share price of £2.29 gives a yield of 8.5%.
Forecasts are for a 20.33p dividend this year, 21.35p next year, and 22.51p in 2025. If the shares stayed at the current price, then the respective yields would be 8.9%, 9.3% and 9.8%.
Even at an 8.5% yield, a £10,000 investment now would make me £850 per year in second income. If the dividend stayed at that level, then I would make £8,500 in second income over 10 years.
Phoenix Group Holdings
Phoenix Group Holdings (LSE: PHNX) is down 16% from its year high. It also has a very high Solvency II ratio – of 189%. Two boxes ticked for me.
The share price drop means it is currently yielding 9.3%. This comes from the 2022 dividend of 50.8p per share and the current share price of around £5.43.
This high dividend is not a flash-in-the-pan. In 2021, it paid 48.9p (7.5%), and in 2020 the payment was 47.5p (6.8%).
If I invested £10,000 in the stock now, I would make £930 this year in second income from it. If such a payout level remained in place for 10 years, then my £10,000 investment would have made another £9,300.
Together, then, these two stocks would yield £1,780 per year in second income for me. This would mean that over 10 years, I would have made an additional £17,800 to my £20,000 total investment.
These returns do not include further gains from any reinvestment of dividends or share price appreciation. They also do not include tax liabilities and don’t take into account any issues that might arise.
I already hold Legal & General and am happy with my position. I am also seriously considering buying Phoenix Group Holdings. I believe the losses in the share price are unwarranted and will be reversed over time. I also expect it to stick to its history of paying healthy yields.