Investing in dividend stocks within an ISA can be a great way to create a passive income stream. Not only is it possible to beat the returns on offer from savings accounts, but income can be tax-free.
Here, I’m going to show how an investor could potentially generate income of nearly £1,500 a year with just five stocks. Could this kind of strategy help you achieve financial independence?
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Building a high-yield portfolio
In the table below, I’ve put five FTSE 350 stocks along with their forward-looking dividend yields. Note that these yields are based on analysts’ estimates for dividend payments and they may not be accurate.
| Stock | Dividend Yield |
| Aviva | 6.8% |
| M&G | 7.5% |
| Primary Health Properties | 8.0% |
| Supermarket Income REIT | 7.9% |
| Domino’s Pizza (LSE: DOM) | 6.3% |
| Average yield | 7.3% |
The average yield across those five stocks is 7.3%. This means that if an investor was to split £20,000 across these names, they could potentially be looking at income of around £1,460 per year.
What’s the catch?
That’s obviously a fair bit of income from a £20,000 investment. So what’s the catch? Well, first, dividends are never guaranteed as companies can reduce or cancel them at any time and second, capital’s at risk (unlike with a bank account).
These are all solid companies. However, they all face risks and investors could potentially experience share price losses.
In the case of Aviva, for example, its share price could drop if the stock market continues to fall. Because lower equity markets will translate to lower earnings on investment assets under management.
Turning to Primary Health Properties, its share price could fall if interest rates rise. Because it’s a property company.
Given that each company has its risks, it wouldn’t actually be very smart to allocate all of a portfolio to just five stocks. If one or two names tanked, it could really hurt overall returns.
Generally speaking, it’s sensible to own at least 15-20 different names when investing in individual stocks. This can significantly reduce stock-specific risk.
Worth a closer look?
Going back to the five names though, I think they’re all worthy of further research today. I’ve selected them because they either offer value or defensiveness, alongside a high yield.
Of the five, one worth highlighting is Domino’s Pizza. It has the highest dividend coverage ratio (the ratio of earnings per share to dividends per share) at about 1.6, meaning that, in theory, its dividend is the most secure.
Other things to like include its strong brand and high level of profitability (its franchise model’s very profitable). These attributes often lead to good results from an investment perspective.
On the downside, consumer habits and preferences are changing. Weight-loss drugs are a risk here – reducing appetites and cravings.
Competition’s also high. Today, there are lots of great places to pick up a tasty pizza cheaply. Overall though, I believe Domino’s is worth a closer look. With analysts forecasting earnings per share of 18.1p this year, the price-to-earnings ratio’s under 10.
