Building a sustainable second income stream isn’t exactly straightforward. If it were, everyone would do it! But it’s certainly possible. It just requires some time, planning and dedication.
Looking at the UK stock market today, there are a few ways I can see to maximise its potential. Investing in dividend stocks with a long-term view is one tried and tested method. But which stocks to choose?
Top-performing stocks always look attractive as the companies in question are clearly doing something right. However, it might be hard to extract significant returns out of a stock that’s already highly valued.
I prefer to look for beaten-down stocks from companies with a long history of strong performance. The fall in price is likely temporary, so grabbing some shares while they’re cheap could equate to lucrative returns in the future.
With that in mind, potential investors may consider this promising British insurance provider that’s had a rough few months.
A bright future
Phoenix Group‘s (LSE: PHNX) one of the largest long-term savings and retirement businesses in the UK. Specialising in life insurance, pensions, and asset management, it primarily focuses on acquiring and managing closed life insurance and pension portfolios.
These books are policies no longer sold to new customers but are still being managed to maturity, providing a predictable cash flow.
It also provides retirement solutions to individuals and businesses, helping clients manage long-term savings and retirement income. This sector is of rising importance due to demographic changes and the UK’s ageing population.
Dividends
It’s no surprise that the dividend yield of 10.9% was the first thing that caught my attention. A yield that high could equate to a decent amount of regular income. But yields tend to move in direct contrast to the price.
If I expect a price recovery, I should also expect the yield to decrease. When calculating long-term returns, it’s better to use an average. Phoenix appears to have maintained an average yield of around 7% for the past decade.
My calculations
Using a discounted cash flow model, the Phoenix share price is estimated to be undervalued by 21.2%. Earnings are forecast to grow at 76% a year going forward, suggesting a recovery may be on the cards. If it were to grow at the same rate it did between 2010 and 2020, it could deliver annualised returns of 5% a year.
With those averages, the miracle of compounding returns mean a monthly investment of £300 could grow to £300,000 in 20 years (with those dividends reinvested). Assuming the 7% average yield held, that pot would pay a second income of £19,000 a year in dividends.
Relevant concerns
It may be a good plan but it’s not without risk. Insurance companies are heavily exposed to interest rate fluctuations, which impact the discount rates used to value their liabilities. That could suppress earnings and hurt the share price
Phoenix also invests in bonds and fixed-income securities, so it faces credit risk if these assets default or are downgraded.
On the plus side, the group recently appointed a new CFO and implemented a share incentive plan for employees. Overall, I like the direction it’s heading and think the low valuation makes it worth considering as part of an income portfolio.
