I dream about the power of dividend stocks, slaving away for me while I peacefully slumber. If I could earn £18,250 in dividends a year, that’s £50 a night!
This is no easy feat but it’s possible. And if a Fool like me can dream it, anybody can. To do so, I’d need to harness the magic of compound returns, combined with a large initial investment and monthly contributions to a portfolio of winning stocks.
How?
The average UK investor can expect 7.5% returns with a 5.5% average dividend yield. If I invest an initial £10,000 in this portfolio and add £300 a month, it could reach around £400,000 in 20 years, paying annual dividends above £18,000 a year – almost £50 per day.
Of course, it’s not guaranteed and I could lose money as well as make it. There are also some steps I’d need to take to achieve my goal.
Death and taxes?
First, I’d need to find the most cost-effective way to invest in stocks. Benjamin Franklin once famously stated that “nothing is certain, except death and taxes”. Well, I dispute that claim.
For UK citizens, a Stocks and Shares ISA allows up to £20k a year of investments in all kinds of assets and the capital gains are tax-free. So I’d start by opening one.
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Don’t cry, diversify!
So now all I’d need to do is throw all my cash in the highest-paying dividend stock, right?
Wrong. All my money in one basket is a recipe for disaster. If it fails, the dream ends. I’d need to spread my investment over a range of shares in different industries so no single failure would hit me hard.
There isn’t space to name every good stock here are two.
A defensive construction stock
One small-cap AIM stock that’s been doing well recently is Billington (LSE:BILN), a structural steel and construction specialist based in Barnsley. Revenue is up 53% this past year and it doubled its earnings per share (EPS) and dividends. It pays a handsome 5.6% yield following efficiency improvements that boosted margins.
But the good times won’t necessarily last. The UK steel market is expected to fall 5% this year, reducing Billington’s revenue and pre-tax profit forecasts. Still, future return on equity (ROE) is forecast to be 12.7% in three years – ahead of the 11% industry average. Long-term I think its prospects are good, and dividends will help cover any short-term dips.
A riskier high-yield stock
As an alternative, I’d choose a few large-cap FTSE 100 stocks like Legal & General (LSE:LGEN). An even more powerful and consistent dividend payer, it boasts an 8.2% yield and a strong track record of increasing it. Annual payments are up from 9.3p in 2014 to 20.3p today. Recently, however, EPS has dipped to only 7.4p, resulting in limited dividend coverage. With a payout ratio of 277%, earnings will need to improve if Legal & General hopes to keep paying its high dividend.
Consensus from several analysts expects earnings to increase to £1.7bn by 2026, up from £435m earlier this year. Historically, the company has managed to cover its dividend payments so I’m fairly confident this will continue.
Mixing up some risky value stocks and some reliable growth stocks would help to keep me on an even keel as I navigate the economic tides.
