Building a second income stream from the FTSE 100 might seem like an unrealistic goal at first. However, I’ve done just that with my two favourite blue-chip dividend stocks, Admiral (LSE: ADM) and Standard Life (LSE: SLA). Today, I’m going to explain how you can do the same.
The best income stocks
The best income stocks are companies that have a track record of returning cash to investors, but it would be misleading to say that the stocks with the highest dividend yields are always the best.
When I’m looking for attractive investment for my income portfolio, I always consider how sustainable the payout is first, before looking at the yield.
Take Admiral, for example. The company’s management has adopted a flexible dividend policy, whereby investors are entitled to a regular distribution every year and a special payout, which is flexible. I think this policy is much more sustainable in the long term. Companies that commit themselves to progressive dividend policies often end up having to cut their dividends or reduce investment to meet obligations if the business begins to struggle. Neither of which is a desirable outcome for shareholders.
Admiral reported record profits for the first half of its most recent fiscal year, and City analysts expect this to translate into a record dividend from the company. They’ve pencilled in a potential full-year 2018 distribution of 117.4p, giving a dividend yield of 5.5%. The payout is expected to grow further in 2019 with a potential yield of 6.2% on offer.
Not only do I think Admiral is capable of meeting this higher payout, but I’m also highly optimistic on the outlook for the group’s dividend. The company is just starting to reap the rewards of its international expansion and growth into new markets at home, such as loans, are fuelling profit growth here.
I’m attracted to Standard Life for different reasons. The company currently supports a dividend of around 9.5%, which looks extremely attractive at first glance.
However, under further scrutiny, it becomes clear that this distribution might not be sustainable. For example, it’s not currently covered by earnings per share.
If I am brutally honest, I would say a dividend cut is on the way at some point of the next few years. But I’m not expecting much of a reduction because Standard’s business model doesn’t require much capital investment, so it can afford to return virtually all of its earnings to investors. Cutting the dividend by just 2p per share would be enough to push dividend cover back above one, and the stock would still yield a little over 8.7% at current levels.
So it looks to me as if the company will remain an attractive income investment even if it does decide to reduce shareholder distributions.
That’s why I’m more than happy to pay the current valuation of 11.2 times forward earnings to buy shares in Standard Life for my income portfolio today.
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Rupert Hargreaves owns shares in Admiral and Standard Life Aberdeen. The Motley Fool UK has recommended Standard Life Aberdeen. 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.