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How I’d build a second income stream with these 2 FTSE 250 dividend stocks

Earning a passive income from the stock market can be a powerful way to boost your earnings. Done right, you can earn a dividend yield that’s higher and grows faster than the payout from a FTSE 100 tracker fund.

For this strategy to be successful, I believe you need a mix of dividend growth and high-yield stocks.

These two could beat the market

Today I want to suggest two stocks — one for growth and one for high yield. My sums show that these two shares offer an average forecast dividend yield of 5.5% for the current year, with an average dividend growth rate of 3.6%.

To put that in context, inflation is currently 1.8%, so the dividend income from this pair of stocks should rise significantly faster than the cost of living. The yield of my pair is also better than the market average dividend yield, which currently stands at 4.4% for the FTSE 100 and 3.2% for the FTSE 250.

Of course, owning just two stocks is much riskier than a tracker fund. I would normally aim for a portfolio of 10 to 20 stocks for income investment. But I think these two companies give us a good idea of what’s on offer for dividend hunters.

Pick #1 – dividend growth

Homewares retailer Dunelm Group (LSE: DNLM) is bucking the trend and delivering solid growth at the moment. The company reported like-for-like sales growth of 6.9% during the six months to 31 December, with store sales up 3.8% and online sales up 35.8%.

Pre-tax profit for the period rose by 24% to £70m, lifting the company’s operating profit margin for the half year to 12.8%, up from 10.6% for the same period last year. Cash generation was also strong and free cash flow rose to £91.2m during the period. This enabled the group to reduce net debt by £61m to £73m and to increase the interim dividend by 7.1% to 7.5p per share.

Dunelm shares aren’t the cheapest in this sector. They currently trade on about 16x 2019 forecast earnings, with a 3.8% dividend yield. But this company is growing, is very profitable, and has never cut its dividend since floating in 2006. In my view, the shares are fair value at current levels.

Pick #2 – high yield

Life insurer Phoenix Group (LSE: PHNX) is a long-running favourite of mine. I like the firm’s specialist focus and its impressive track record of generous dividends.

The company isn’t well-known among investors, perhaps because it doesn’t sell insurance to the general public. Instead, this firm buys up so-called ‘closed books’ of life insurance policies from other insurers and then runs them to completion.

It’s a business that’s designed to generate a lot of surplus cash, much of which is returned to shareholders. For example, Phoenix generated £664m of cash in 2018 and is expected to pay about £330m in dividends for the year.

At current levels, Phoenix shares offer a forecast yield of 7.3% for 2019. I expect this payout to be well supported by the group’s cash generation. In my view, the stock rates highly as a pure income buy.

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Roland Head has no position in any of the shares mentioned. 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.