Just how much money does it take to make money? Or, put another way, if someone wanted to target a second income of £500 a month on average without working for it, what sort of investment in dividend shares might help them hit that goal?
Dividend yield: important, but be careful
The answer to that question depends on the average dividend yield their ISA earns.
Dividend yield is basically how much someone earns in dividends annually, expressed as a percentage of what they paid for the shares that pay them.
So, take the £500 as an example. That is £6k per year.
At a 10% yield, that would require an ISA worth £60k. Halve the yield and the requirement doubles: at a 5% yield, the ISA would need to be £120k.
That makes it sound like the way to go could be to buy high-yielding shares.
But looking out the window today and seeing that today is sunny does not automatically mean the weather will be sunny a month from now.
Similarly, historic dividend performance can tell us something about how a company’s business has performed in the past – but is no guarantee it will do so in future.
I try to look at how much spare cash a company looks set to generate in future.
That is a judgement and it could be proved wrong: even the best businesses can run into unforeseeable difficulties. Diversifying the ISA across different shares can help reduce the impact of such events on the second income, but it is also important to focus on the quality of the shares one buys.
Setting a realistic target
If 10% seems unrealistic (no FTSE 100 share currently offers such a yield although some FTSE 250 ones do), what about 5%?
It is well above the current yield of either of those indexes, but I do see it as a realistic target in today’s market.
I said above that would make a Stocks and Shares ISA worth £120k. But that does not need to be a lump sum.
Someone could start from nothing and build up the ISA to that size through regular contributions, perhaps speeding things up by initially compounding (reinvesting) dividends.
Why not consider this dividend share?
One share I think investors ought to consider for its dividend potential is ME Group (LSE: MEGP).
After a 22% share price fall over the past year, the operator of Photo-Me booths sells for just 10 times earnings and offers a 5.8% dividend yield. I see that as attractive.
Demand for passport photos and mementos is proving more durable in the digital age than some people expected, although long-term decline in photo booth use is a risk for the FTSE 250 company.
Fortunately, it has many other strings to its bow, from laundry machines at garages to orange juice makers in some of the many markets in which it operates globally.
This is a cash generative business, which can be good news for dividends.
A recent delay in last year’s results unnerved the City. But when published, they revealed a 9% uplift in cash generated from operations, to over £2m per week on average. The annual dividend per share was boosted 10%.
