I’d aim for an annual second income of £34k with high-yield dividend stocks

I’m looking for the best way to start earning a second income with very little effort. Is it by investing a large sum into high-yield dividend stocks?

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Windmills for electric power production.

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There are several strategies when it comes to investing for a second income. Some aim for slow-but-reliable gains over a long period. Others aim for high returns from undervalued shares with growth potential.

I think buying stocks with high yields and reinvesting the dividends to compound the returns is a good strategy. But while some of the highest yields go up to 15% or more, they aren’t necessarily reliable. It’s best to choose stocks with a long track record of making payments and increasing the yield.

A good example is Greencoat UK Wind  (LSE:UKW) , a FTSE 250 real estate investment trust (REIT) that invests in the renewable energy sector. REITs provide a 20% tax-deductible benefit for individual shareholders.

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.

Harnessing the power of wind

Greencoat UK Wind specialises in onshore and offshore wind farms. With renewable energy on track to reach a goal of triple capacity by 2030, demand for wind power should remain high. The company’s assets already supply 10Mw of power to UK homes and last month it signed a new 10-year Power Purchase Agreement (PPA) for its Ballybane Phase 1 wind farm.

With a 7.5% dividend yield, it’s double the FTSE 250 average yield of 3.23%. It’s been paying a dividend consistently for over 10 years, during which time it has mostly been between 5% and 6%. However, the share price of £1.35 hasn’t changed much in five years, other than a brief increase during 2022. But that wouldn’t concern me much. It’s fairly common of income shares, which focus on providing returns via dividends.

Financials and risks

While the trust’s dividends are steady and reliable, earnings and revenue are in decline. Projections indicate it could become unprofitable next year. With increased investment pushing up the share price, its price-to-earnings (P/E) ratio is now at 25 times. That’s a lot higher than the industry average of 16.8.

This also means earnings per share (EPS) has decreased to 5.5p — well below the current 13.7p dividend. As a result, the yield might be reduced later this year or next. However, based on the prior 10-year track record, payments should remain consistent.

The bottom line

Greencoat UK Wind has a solid balance sheet that seems stable enough to handle a period of losses. It’s debt of £1.8bn is well-covered by equity and assets significantly outweigh liabilities. Its debt-to-equity (D/E) ratio is 47% and interest coverage is 3.1 times.

With strong industry growth and an exceptional track record, I believe the trust will continue to pay reliable dividends for the indefinite future. And I’m not alone. On 22 May, Barclays put in an overweight position for the stock, indicating it believes the stock will outperform its sector average over the next eight to 12 months. 

As such, I think it would make a great additional to a dividend portfolio aimed at building a second income stream. If I invested £20,000 into a portfolio with an average yield of 7% and a 2% annual price increase, it could grow to near £400,000 in 30 years. It’s not guaranteed, but that amount would pay out a second income £34,500 in dividends per year.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Mark Hartley has positions in Barclays Plc. The Motley Fool UK has recommended Barclays Plc and Greencoat Uk Wind Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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