The London Stock Exchange is notorious for offering impressive dividend yields. With a vast array of mature industry leaders, British investors are spoilt for choice when it comes to finding passive income-generating stocks. And while the stock market rally of 2024 has brought overall yields down, there are still plenty of income opportunities to capitalise on.
With that in mind, here’s how I’d build a £10,000 portfolio in 2024 to earn a 7% yield.
Quality of quantity
The easiest way to create a high-yield portfolio is to just fill it with high-yield stocks. Right now, across the FTSE 350, there are just over 30 companies offering yields of 7% or more. That’s more than enough to build a diversified portfolio. And since several of these businesses are paying higher than 7%, the resulting passive income could venture into double-digit territory.
The problem with this approach is that it seldom leads to investment returns. In fact, there’s a high probability investors would end up destroying wealth rather than creating it. Don’t forget yield is also a function of share price. When the market cap of a company suddenly drops, the yield goes up. And in most cases that only happens when something has gone horribly wrong.
Instead, investors focus on the quality of the dividend rather than the quantity, even if that means filling a portfolio with lower-yielding stocks. But then, how do we bring this yield back up to the target of 7%?
The key is to focus on a firm’s free cash flow. This is the money left over after a company has covered all its operating expenses and financial obligations. It can be used in several ways, like paying off debt, ramping up investment, executing buybacks, or paying dividends.
The more free cash flow a business generates, the more financial flexibility it has. And it also opens the door to dividend hikes, which, in the long run, can grow a mediocre dividend yield into a far more exciting one.
From mediocrity to supremacy
Probably one of the greatest examples of free cash flow expansion in the FTSE 350 is Safestore Holdings (LSE:SAFE), which is worth considering.
The enterprise owns and operates a network of self-storage facilities that individuals and businesses can rent. While developing new locations is expensive, the actual cost of running a self-storage facility is relatively low. And with recurring revenue pouring in each month, Safestore’s free cash flow margins have averaged an impressive 55%.
This has subsequently paved the way for almost 15 years of consecutive dividend hikes, with payouts growing by an average of 17.4% each year. So, how has this affected the dividend yield?
In November 2014, Safestore shares were trading at around 212p with dividends at 7.45p. That translates into a fairly average yield of 3.5%. But today, the payout per share is closer to 30p. And so, on an original cost basis, the dividend yield has since grown to 14%!
Safestore isn’t the only business to have delivered impressive dividend growth over the years. And there are plenty of Safestore-like stocks listed in the UK for investors to capitalise on. That’s why if I had £10,000 to build a passive income portfolio right now, I’d ignore the obvious high-yield offerings and focus on the companies that can systematically raise shareholder payouts for decades to come.
