Typically, an investor focuses on the dividend yield of a particular stock when trying to weigh up whether to buy or not. Instead, it’s possible to look at targeting a specific group of stocks for passive income potential. For example, what if someone had a £5k pot and wanted to allocate it to a handful of high-yielding options? Here’s what it could look like.
Pushing the limits
I’m going to assume that the £5k is split between five different options with £1k allocated to each idea. In filtering for the top yielding shares in the FTSE 100, this would include M&G, Legal & General (LSE:LGEN), Phoenix Group, Taylor Wimpey and British American Tobacco. The average yield for this group of stocks would be 8.38%.
This means that over the course of the next year, the £5k total could yield £419 in dividend income. This is very respectable and hard to beat given that this basket is the highest-yielding options in the index. The only way to achieve an enhanced yield would be by dropping some stocks. Yet this also increases the risk as the money is less diversified between companies.
The FTSE 100 average yield is 3.41%, so it shows how active stock picking can provide an enhanced income payout. However, there’s still the need to be cautious. High yields can sometimes be dangerous if the share price has fallen rapidly. It could be a sign there’s something wrong with the business. Although the stock fall pushes up the yield, it might lead to the dividend per share being cut if the business is genuinely struggling.
A reliable option
One pick within the group that I think is a sustainable income option is Legal & General. The stock’s only down a modest 2% over the last year, easing concerns that the high yield is due to a share price crash.
In fact, the financial services company has been doing well. The full-year results that came out in March showed core operating profits rose 6% versus the previous year to £1.62bn. Alongside news of a £500m share buyback, shareholders were also rewarded with a 5% increase in dividend per share payments.
Looking forward, I don’t see material problems for the company, based on the business model. It has a good track record from harvesting insurance premiums and investment management fees. The stability of cash flow that this provides is good for income investors. Of course, an ongoing risk is if business clients withdraw their money in large amounts. This reduces the assets under management and therefore the fees earned for the money.
I think an investor could consider including Legal & General in an existing income portfolio, or with this particular five-stock concept.
