I’m a big fan of dividend shares. Not because I like to spend the payouts on frivolous things but, instead, they enable me to buy more shares. That way I can take advantage of compounding, which has been described as the eighth wonder of the world.
April is the time of year when those investors fortunate to have some spare cash think about using some (or all) of their ISA allowance.
Unfortunately, I’m currently not in a position to invest. But if I was lucky enough to have £20,000 available — the full amount that can be put into an ISA — here’s what I’d buy in an attempt to grow it to nearly £100,000 within 20 years.
Top of the shop
Topps Tiles (LSE:TPT) claims to have a 20% share of the wall and floor tiles market, which it says is worth £1.2bn a year. Due to its strong balance sheet (it has no debt) and healthy cash generation, it’s able to pay a generous dividend. The company’s pledged to return at least 67% of adjusted earnings per share to shareholders for the foreseeable future. Presently, the company pays 3.6p — a current yield of 8%.
However, the company has two potential problems. Firstly, it operates a chain of 303 stores, which might come under threat from the internet. Secondly, it’s small, which means it’s vulnerable to a market slump, despite it making a commitment “not to decrease cash payments due to any short-term economic turbulence”.
But if I were to invest a quarter of my hypothetical £20,000 into the stock, based on a current share price of 45p, I’d expect to receive £400 in dividends over the next 12 months. If I reinvested this amount, I could buy a further 888 shares, assuming the share price remains unchanged. In year two, I’d then receive £432. Repeating this exercise for 20 years, would enable me to buy 40,677 additional shares. My initial £5,000 would then be worth £23,304.
Other stocks
Diversified Energy Company has recently cut its dividend by 67%. That sounds alarm bells but the US gas producer still plans to pay $0.29 (22.94p) a quarter, which means the shares are presently yielding over 10%. This could turn £5,000 into £37,162 over 20 years.
There are also a couple of FTSE 100 stocks that I think have the potential to offer generous and reliable dividends. Both should do well if the UK economy grows as predicted.
For its 2023 financial year, NatWest Group declared dividends of 17p a share. With a present yield of 6.5%, reinvesting the payouts could turn £5,000 into £17,606, over 20 years.
Taylor Wimpey offers a slightly better yield (6.9%). Assuming its dividend is maintained, and no change in the housebuilder’s share price, a quarter of my stake could grow to £18,851.
What does this all mean?
If the above came true, my initial £20,000 would be worth £96,923 after two decades. This ignores any potential capital growth (or losses).
But dividends are never guaranteed. And I would also like to do a little more research before committing to buying some of these stocks. That’s because earnings can be volatile in the industries in which they operate. But this exercise shows how it’s theoretically possible to build a significant portfolio by investing in dividend shares.
