Building a passive income stream from dividend paying stocks is a tried and tested method many seasoned investors undertake.
The general rule of thumb is that diversification is a must to ensure maximum returns, as well as protection for my portfolio.
However, let’s say for the purposes of this article I had to choose just two stocks to build my additional income stream. I’d choose National Grid (LSE: NG.) and GSK (LSE: GSK) shares to buy.
Here’s why!
National Grid
The owner and operator of the gas and electricity transmission system in the UK is a rock-solid stock, in my view.
A big part of this is due to its monopoly on operations in the UK and its defensive traits. It’s the only provider of its kind, so competition isn’t an issue.
From a defensive view, energy is a basic requirement for all. We all need gas and electricity, no matter the economic outlook.
Both of these aspects allow revenues to remain stable, and therefore provide consistent investor rewards.
From a fundamentals perspective, a dividend yield of over 5% is attractive. This is higher than the FTSE 100 average of 3.9%. However, it is worth remembering that dividends are never guaranteed.
Moving on, the shares look good value for money to me on a price-to-earnings ratio of 15. This is slightly above average because of the level of security the stock offers, in my view.
Despite my bullish stance on the stock, there are risks to bear in mind that could hurt payouts. To start with, it has a fair bit of debt on its balance sheet, over £45bn at present. Paying this down could hurt payout levels.
In addition to this, the investment required to maintain a large, vital piece of infrastructure in the country could be hugely expensive. This investment could also impact shareholder value and dividends.
Overall, a defensive stock with a monopoly, as well as an attractive return level and valuation help my investment case.
GSK
As one of the world’s largest pharmaceutical research businesses, GSK possesses an enviable track record of performance. Furthermore, its brand power and market position are also major draws.
From a risk perspective, pharma stocks are prone to issues such as R&D complications. There is every chance that product launches, trials, and other issues could hurt GSK’s investment viability if they fail. Plus, these same issues could dent performance and returns.
In addition to this, actually creating a treatment or drug can cost millions, if not more just to bring to market. Lots of investment is required, therefore spending lots in this stage and a poor return on investment in the form of sales could hurt dividends.
However, GSK’s current burgeoning pipeline and experience offer me solace. Plus, the shares look good value for money on a price-to-earnings ratio of just 10. Plus, a forward dividend yield of just over 4% is attractive.
Finally, GSK does have a sense of defensive ability too, if you ask me. This is because demand for healthcare, pharma products and treatments are basic requirements. Plus, as the global population continues to increase, GSK could capitalise.
