While Vodafone offers a whopping 10.4% dividend yield, that’s set to be cut in half from next year. Therefore, as I write, the highest-yielding stock on the FTSE 100 is insurance player Phoenix Group Holdings (LSE: PHNX) with a thumping dividend yield of 9.8%. But how could I translate that enticing payout into a stable second income?
Let’s assume that I had £11,000 saved. That’s around the average amount of savings in the UK. I could leave that in the bank and probably find a savings account with a pretty decent interest rate. But interest rates are beginning to be cut. And when they fall, so will the rate I receive.
Instead, I’d put it to work in the stock market.
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Breaking it down
Taking Phoenix Group’s yield and applying it to my lump sum ought to see me earn £1,078 a year as a second income. I could withdraw that money every year and put it towards bills or luxuries such as holidays.
However, I wouldn’t do that. Instead, I’d reinvest every dividend I received into buying more shares. That way, I’d benefit from ‘dividend compounding’.
If I did that for 25 years, by then I’d make a second income worth £11,736. Moreover, my lump sum would have grown from £11,000 to £126,203.
What’s even more impressive is that if I invested a further £100 a month alongside my £11,000, after 25 years, I’d earn a second income worth £23,601.
Diversification is key
Of course, that’s assuming a few things. First, that assumes the share price and yield don’t change (unlikely, although it’s still a worthwhile exercise). While I’d hope to see growth in its share price and payout, I’m aware the opposite could happen.
On top of that, that’s assuming I invested all my savings into one company. While that may seem like a smart idea, it makes me prone to volatility.
That being said, I still think Phoenix Group would be a savvy buy as part of a diversified portfolio. If I had the cash, I’d buy the stock today.
Rising yield
The insurance giant hiked its dividend by 3.6% last year to 52.7p. It has been steadily increasing its dividend over the past decade, which I always like to see.
Furthermore, analysts expect this to continue. The stock has a forecast yield of 9.9% in 2024. That rises to 10.3% in 2025. Not bad.
A forecast rising yield is all well and good. However, investors should be do their due diligence to see if a dividend is sustainable.
Phoenix Group has a solid balance sheet with a Solvency II capital ratio of 176%. Last year it generated £2bn of cash, exceeding its target by £200m. Both of those will help prop up its dividend.
The insurance industry is cyclical, which is a risk. Its share price has suffered over the past couple of years as red hot inflation has dented investor confidence. High rates also negatively impact the value of Phoenix Group’s assets. So, a delay in future rate cuts would spell trouble.
But its share price has been making up good ground recently. From its April low, it has risen 13.8%. The shares don’t look too badly priced though, trading on just 11.4 times forward earnings.
