British citizens planning for retirement often invest in dividend shares to aim for passive income down the line. The beauty of this method is the compounding opportunities it provides through reinvestment. Until such time as the money is needed, funnelling dividends back into a portfolio helps supercharge growth.
Fortunately, the UK stock market hosts a treasure trove of dividend-paying companies. From mega-cap multinationals on the FTSE 100 to up-and-coming domestic gems on the FTSE 250, we have a wealth of options to choose from.
Currently, one stock that’s been catching my eye is Investec (LSE: INVP), a British/South African investment bank headquartered in London.
An undervalued dividend machine
With a 6.1% dividend yield, Investec’s by no means the highest payer on the market. Still, it’s significantly higher than the FTSE average of around 3.5%. Plus, with only 50% of earnings being paid out as dividends, it has lots of room to grow. Payouts could also be considered highly reliable, with 2.77 times cash coverage and an uninterrupted 20-year track record.
Last year, the bank boosted its full-year dividend by 5.8% — the fifth year in a row that it’s been increased. Overall, that’s a very impressive set of figures for income-focused investors. But all that means nothing if the stock price is falling, so how stable is the business?
Assessing viability
When investing for passive income, it’s critical to assess whether a business can deliver in the long-term. If profits decline and debt takes precedent, a dividend cut could derail your entire strategy.
The balance sheet is the first place to look. With £7.7bn in debt against only £5.3bn in equity, some investors may be alarmed. In most cases, equity should outweigh debt, but this level isn’t unusual for an investment bank. However, its current ratio of 3.1 is concerning, as too much leverage amplifies earnings volatility and dividend risk during downturns. If interest rates fall, it could compress net interest margins and squeeze profitability.
Encouragingly, the share price is estimated at only 7.7 times forward earnings, suggesting the market may undervalue the company. A strong set of year-end results could ignite investor interest and spark a price rally.
Targeting £1k+
To bring in over £1,000 of passive income with a 6.1% yield, an investor would need at least £16,394 worth of shares. With the Investec share price currently hovering around 621p, that equates to about 2,640 shares.
If an investor bought 50 shares a month for a total of £310.50, it would take less than four and half years to accumulate that many. But £1,000 a year is just the start. Savvy investors usually reinvest their dividends until retirement, thereby maximising the income potential.
Whatever your plan, careful assessment of a company’s financial situation is critical before making any decisions. While Investec is a promising stock to consider, it should be done so as part of a diversified portfolio targeting an average 6%-7% yield.
I’ve recently covered several similar income stocks that would suit such a strategy.
