The past couple of inflation-hit years have shown how a second income can be worth its weight in gold.
For me, the simplest way to generate income is through dividend shares. When carefully chosen, they offer a reliable stream of cash that I can spend, save, or reinvest to fuel the compounding process.
Walk the walk
One thing I want from a dividend-paying firm is a commitment to increasing its annual payout over time.
But hang on. Don’t most companies have a “progressive” dividend policy? Well, yes, in theory. But I want evidence that a company can back up its promise with actions.
The easiest way to judge this is by looking at the firm’s track record. How long has it been consistently increasing its dividend?
Take Diageo (LSE: DGE), for example, which owns category-leading brands like Guinness, Johnnie Walker, and Don Julio premium tequila. It’s increased its payout for over 25 years, making it a Dividend Aristocrat.
My ideal scenario is that a stock pays me income for life. I reckon Diageo has a chance of doing so, which is why I’m a shareholder.
In contrast, some shares have a dreadful track record of creating long-term shareholder value, including BT and Vodafone. So I tend to stay away from these.
Supermarket shelves to pub taps
Now, the caveat here is that even the most well-run companies can come unstuck due to black swan events. The global pandemic, for example, forced many businesses to suspend shareholder distributions.
In most cases, this was a wise move, as nobody knew how long the pandemic would last. Some had to take on huge debt to survive and have only just started paying dividends again. Rolls-Royce is one such high-profile example.
Diageo did carry on paying dividends throughout Covid though, demonstrating the resilience of its business. And last year, even after profits took a hit, it hiked the dividend 5%.
Yet it’s important to be mindful of potential risks to a company’s earnings growth over time. For Diageo, these include Gen Z drinking less alcohol in the West and the threat of weight-loss drugs like Wegovy, which reportedly curb the desire for a tipple or two.
Despite these challenges, I’m confident in the long-term income prospects from Diageo. Its top-tier brands have growth potential in huge emerging markets like India, while it’s also building out its alcohol-free drinks portfolio.
For example, Guinness 0.0 has been gaining serious traction. In the year to June, it doubled its net sales in Europe and became the UK’s number one non-alcoholic beer.
As a shareholder, I felt duty-bound recently to do some boots-on-the-ground research to see what all the fuss was about. I was actually very impressed, and can see why Guinness 0.0 has successfully transitioned from supermarket shelves to pub taps.
Unusually high yield
The Diageo share price has fallen 42% in just under three years. This is due to high inflation, which has caused a severe downturn in the global alcohol industry.
One thing this has done is push up the forward dividend yield to 3.7%. This is historically rare for Diageo and was one reason why I added to my holding a couple of months back.
And, if I hadn’t it done it then, I’d definitely do it today, while it’s down.
