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Forget buy-to-let! I’d buy this FTSE 100 dividend stock for a second income

The classic argument for buy-to-let investing goes something like this. You buy a house to rent out. This provides you with a second income. At some point in the future, you sell the house to help fund your retirement.

It’s a good argument, but soaring house prices suggest to me that it’s harder to make money from buy-to-let than it used to be , especially as costs are rising for landlords.

In my view, now isn’t the time to be buying rental properties. I see much better opportunities for income and growth in the stock market.

A bulletproof 6% income?

I reckon most small landlords will do well to earn an annual yield on their investment of more than 6%, after subtracting the cost of repairs, tax, insurance, and empty periods.

On that basis, oil and gas giant Royal Dutch Shell (LSE: RDSB) looks a much better buy. Shares in this £195bn giant now offer a hassle-free yield of 6.2%, thanks to last year’s oil market sell-off.

In my view, the company’s financial situation is much stronger than this generous dividend yield suggests. Since the oil crash, chief executive Ben van Beurden has cut debt, reduced costs, and focused spending on projects that should be profitable at oil prices below today’s $60 level.

Cash generation has improved significantly. My sums suggest that the dividend should now be covered comfortably by both free cash flow and earnings. I believe this 6% payout is very safe indeed.

Oil demand should remain strong

Oil demand will probably start to fall at some point in the future. But the latest figures from the International Energy Agency suggest this is unlikely to happen before at least 2040.

In the meantime, Shell plans to maximise the cash generation of its oil fields and become the world’s largest producer of liquefied natural gas (LNG) — a fuel that’s likely to remain in strong demand for power generation.

Plans to buyback $25bn of shares by late 2020 should help to support future earnings and dividend. With the stock currently trading on 10 times 2019 forecast earnings and offering a 6.3% yield, I view Shell as an income buy.

What about growth?

For many buy-to-let investors, long-term capital growth is a key part of the attraction. If you’re looking for generous dividends and growth, one of my top picks would be oil services firm Petrofac (LSE: PFC).

This FTSE 250 company is currently the largest holding in my portfolio. I bought the stock after its share price collapsed in 2017 and believe it’s now on the cusp of delivering a strong recovery.

The firm’s latest trading update showed that new order intake in 2018 was stable at $5bn, while net debt fell sharply last year to about $250m.

I’ve also been encouraged by recent trading updates from US oil services giants Halliburton and Schlumberger. Both say that the global oil market is growing, but the US onshore market is slowing. That should be good news for Petrofac, which mostly operates offshore and in the Middle East, and doesn’t operate in the US onshore market.

Petrofac shares currently trade on just 8.1 times 2019 forecast earnings and offer a 5.3% dividend yield. This suggests to me that a lot of bad news is already in the price. I think the shares are a strong buy at this level.

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Roland Head owns shares of Petrofac. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.