Earning passive income in a Stocks and Shares ISA is a proven step forward towards achieving financial freedom. And with the cost of living only rising, having some additional tax-free income from dividend shares can make an enormous difference.
On average, the UK stock market offers an annual yield of around 4%. That translates into about £800 per £20,000 invested. But what if investors want to be a bit more ambitious and aim for £5,000?
Is this level of payout even possible? With the right strategy – yes.
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Aiming for a 25% dividend yield
Today, a few UK dividend shares are offering such a high payout. But in each instance, the company’s in a dire state, some even flirting with bankruptcy.
Clearly, these are not likely to be good investments. So what should investors do instead?
The answer lies among passive income stocks that have a much lower yield. Instead of trying to instantly unlock the largest payout today, investors should focus on the businesses with the ability to expand dividends over time.
Perhaps a perfect historical example of this is Safestore Holdings (LSE:SAFE). The self-storage operator generates recurring and largely predictable rental income from its network of storage facilities across the UK and Europe.
It’s a highly cash-generative enterprise with impressive free cash flow margins used to organically expand operations, which in turn have generated even more cash flow – a wonderful value-building loop.
The result has been a 15-year streak of continuous dividend hikes. And anyone who invested £20,000 at the start of this journey in 2010 has gone from earning a 3.8% yield to just over 25% on an ‘original cost’ basis – enough to earn £5,000 each year.
Still worth considering?
For new investors, Safestore shares currently offer a 4.7% yield today. But could the business replicate its historical success?
The high level of UK competition makes it harder for UK free cash flows to expand as in the past. But in Europe, the story’s quite different.
The self-storage industry is still in its infancy with far fewer large-scale rivals. That’s why Safestore has begun establishing a foothold in countries including France, Spain, the Netherlands, Belgium, Germany, and Italy.
Management’s positioning the business to capitalise on an expected renaissance within the European self-storage space – a market which could be four times the size of the UK by 2030, according to analysts at Grand View Research.
Risk versus reward
The dividend growth opportunity is undoubtedly exciting. However, like all investments, there are some important risks to consider.
Safestore’s balance sheet carries a chunky amount of debt, which is quite a handicap in a higher interest rate environment. After all, the more cash flow gobbled up by debt expenses, the less money is available to fuel dividend expansion.
This also makes international expansion a bit trickier. Higher borrowing costs and property prices raise the cost of growth significantly. And if the company invests in bad locations, growth could struggle to materialise, potentially even destroying shareholder value.
Nevertheless, with such an impressive track record, I think it’s an opportunity worth exploring. That’s why I’ve already added this business to my passive income portfolio. And there are plenty of other dividend growth stocks available right now awaiting discovery.
