I’m sure most people would appreciate a second income. One of the ways I supplement my employment earnings is to invest in UK shares. At the moment, the FTSE 100’s yielding 3.5%. But this is the average. There are a number of stocks that offer a better return.
Take National Grid (LSE:NG.) as an example. Based on a current (23 July) share price of 1,075p — and the dividends it’s paid over the past 12 months (46.72p) — the stock’s presently yielding 4.3%.
But what does this mean?
Some numbers
Let’s assume an investor has £10,000 available and that the 4.3% return remained unchanged for 25 years. If they kept reinvesting the dividends received, after a quarter of a century, they’d have £28,649.
The same yield would then generate a second income of £1,232 a year. Not bad for doing very little. And remember, the initial investment was £10,000 so, in effect, the yield would be 12.3% a year.
Of course, this is a little unrealistic. It ignores any change in the share price (up or down), assumes the dividend remains the same for 25 years (there are never any guarantees) and, unwisely, all of the investment risk is carried by one stock.
But leaving these to one side, it does illustrate the potential returns from buying dividend shares and the power of compounding.
No competition
There are many reasons why investing in National Grid could make sense. Firstly, it has a monopoly in its UK electricity transmission and distribution markets, as well as its gas and electricity businesses in New York and New England. This means it doesn’t have to worry about finding customers.
Its contracts also give it some earnings protection by allowing it to adjust its prices for inflation. Also, the stock’s well-known for its defensive properties. After all, keeping the lights on will never go out of fashion.
But its revenue and earnings are regulated. On the plus side, as long as it meets certain operational targets, it will know — with a high degree of certainty — what level of return it’s going to make. That’s why it seeks to grow its dividend in line with inflation each year.
However, when energy prices spike, it will never be able to make abnormally high profits like some companies in the sector. This explains why it hopes to increase earnings per share by a solid, if unspectacular, 6-8% a year until 2029.
An expensive business
Some concerns have been expressed about the level of the group’s debt. At 31 March, it had borrowings of £47.5bn.
It plans to spend £60bn on infrastructure over the next five years. To help fund this, it announced a rights issue in May 2024. Tapping shareholders for cash could be a sign that the group’s directors felt its debt was getting a little high.
But by surprising investors in such a way, I think it damaged confidence in the group’s management.
However, I think National Grid’s good at what it does. Unlike Britain’s water companies, which also have monopolies, it doesn’t seem to attract a bad press.
And with its reliable, secure and visible earnings stream, I think its dividend’s secure for now. That’s why those looking for a second income could consider adding the stock to their portfolios.
