Dividend shares are an excellent way to earn a second income, in my opinion. I own several in my Stocks and Shares ISA.
These investments pay me cash every quarter. And once purchased, I barely have to lift a finger. Right now, the average FTSE 100 share offers a 3.8% dividend yield.
But with bank savings offering a higher interest rate right now, this might not sound appealing? However, dividend shares have more to them than just the yield. For instance, some companies manage to grow their payouts steadily over time.
Dividend growth shares
These dividend growth stocks can have a surprising effect on an investment in the long run. Billionaire investor Warren Buffett has owned a stake in Coca-Cola for many decades. When he bought it, it offered no more than a 3% yield, much like today.
But this dividend aristocrat has steadily raised its payment every year. It currently pays his investment firm Berkshire Hathaway $736m in dividends. That’s a whopping 57% yield on the $1.3bn he spent buying the shares.
Investing £5k for income
Some FTSE 100 dividend shares offer yields over 8%. But even this would just produce £400 a year if I invested £5,000. I can hardly call that a second income.
But it’s a start. Investing is typically a long-term activity. And if I could save and invest £5,000 a year for a decade, I calculate I’d end up with a sum worth over £72,000. And that should be enough to earn around £5,760 of annual income.
To get started, I’d look for high-quality dividend growth shares.
Which shares?
In addition to regular dividends, some companies decide to give excess profits to shareholders with what’s known as special dividends.
For instance, last year discount retailer B&M European Value Group (LSE:BME) paid regular dividends of around 2.75%. But after adding special dividends, its yield equated to a chunky 6.5%.
That’s why it pays to look at the detail.
B&M is one share that I’d put at the top of my buy list. It’s a company that’s made steady progress over the past five years, despite challenges during the pandemic.
On average, sales have gained by 11% a year and net profits by 13% a year over the past five years.
Expansion plans
It currently owns 717 stores in the UK, and is on track to open 45 more this year. In addition, it operates stores in France and under the Heron Foods brand, where it also plans to expand.
More stores should drive sales higher. Bear in mind that some organisations struggle to expand profitably and building new stores can be a challenge.
That said, so far B&M seems to be doing a stellar job. One measure of business quality I look for is return on capital employed, and here it offers a solid 20%.
Also, I’d note that dividend shares like B&M aren’t high-growth stocks like Nvidia. Investment gains aren’t likely to shoot the lights out, in my opinion.
But it’s a sound expanding business, which could offer reliable and steadily growing income for years to come.
