UK shares are ridiculously cheap today. While this hasn’t been great for short-term capital growth, it has created an exceptional opportunity to lock in mighty dividend yields. And this could reward investors with high-yield passive income for years to come.
Here, I’ll explain how I’m going about trying to take advantage of this opportunity to build a dividend portfolio.
A best friend
If I didn’t already have a Stocks & Shares ISA, I’d open one immediately.
Why? Because they shield UK investors from paying tax on their investments inside them. More importantly for our purposes, that means all of the passive income generated by my dividend shares becomes tax-free.
That might not matter at first as pennies become pounds. But as hundreds of pounds ideally becomes thousands, it obviously starts to matter a great deal.
So that’s why I consider a Stocks & Shares ISA to be an investor’s best friend.
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.
High-yield stock
Right now, the FTSE is packed with ultra-high-yield shares, far too many to list here. But one I’ve recently been snapping up is insurer Legal & General.
The financial sector has fallen out of favour lately due to uncertainty around inflation and high interest rates. But I don’t think it always will be.
Meanwhile, the Legal & General dividend yield on offer is a mountainous 9.4% yield!
No payout is set in stone, but this is a top-notch income stock, in my eyes. And I’m hoping to collect those juicy dividends while I wait patiently for a potential recovery in the share price.
Thinking more broadly
An extremely high dividend yield can often be a red flag. Not all that glitters is gold, after all.
So it’s crucial to dig in and really understand if a company can afford to pay its dividend. There are many sites and services that can assist here, including The Motley Fool.
But it can help to broaden one’s search beyond just high yields. For example, investment trust Scottish American Investment Company (SAINTS) ‘only’ yields 3.1%. But it hasn’t cut its dividend since 1938!
The trust’s top holding is Novo Nordisk, which is expecting specular growth from its weight loss drugs, Ozempic and Wegovy,
So it can be advantageous to also sacrifice a bit of yield for quality. I’ve been topping up on SAINTS.
Why?
The London market now trades on just 10 times forward earnings. That’s nearly 50% less than the S&P 500 (18.8).
So why are UK shares so cheap?
Unfortunately, this isn’t an easy issue to unpack. Some blame Brexit and sluggish economic growth. Also, having three prime ministers in a single year (in 2022) can’t have helped.
It could be four PMs in three years before too long. That’s a higher turnover than most FTSE 100 companies!
Another issue is the lack of highly valued tech giants in the UK. I think this is a valid reason, because if we strip out those North American mega-cap stocks, the UK-US valuation gap narrows significantly.
I certainly don’t think there is anything fundamentally wrong with most UK-listed stocks. It’s just that the London market is lacking in these highly valued tech giants.
Anyway, most tech stocks don’t usually pay juicy dividends. So I’d rather fish in the UK market for high-yield passive income.
Beyond 2024
Let’s assume I’m able to max out the ISA annual contribution (currently £20k a year) next year. Then I could be generating £1,400 in passive income if my ISA yields 7%.
But if I were to keep going and reinvested my dividends along the way, I’d have about £502,580 after 15 years. From this, I could then hope to be making around £35k in passive income, again with that 7% yield.
