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I am a firm believer in passive income – income that I earn without working for it. Of the dozens of types, my favorite is the free cash I get from dividends.
Three big problems with earnings
However, I have three major problems with the dividend. The first is that most companies listed in the UK do not pay any cash dividends. This is particularly the case with smaller companies, which are investing their cash flow to drive future growth. I get around this problem by looking for profits in FTSE 100 index. Within this index of large companies, all but a few blue-chip companies pay a regular dividend.
My second issue is that future dividends are not guaranteed, so they can be cut or canceled at any time. For example, during the Covid-19 crisis of 2020, dozens of British companies reduced or withdrew their cash payments without notice.
Third, even the largest companies sometimes drop their dividends during lean years. But my 36 years of investing have shown that dividends account for perhaps half of my long-term returns from stocks. So I stick faithfully to my strategy of being a value/dividend/income investor, no matter what.
Low income stocks
I create a more reliable dividend income stream through diversification. By diversifying my stock portfolio, I spread my money across a lot of different baskets by owning, say, 20+ different stocks. This also adds balance and heft to my portfolio during periodic market crashes.
By investing in a wide range of quality companies at affordable prices, my wife and I have built up enough passive income to retire today. But since we enjoy our jobs, we keep working.
However, we are always looking for new stocks to add additional income over dividends to our family portfolio. Here are three cheap stocks we bought last summer for their delicious dividends:
| a company | Legal and public group | ITV | Rio Tinto |
| index | FTSE 100 index | FTSE 250 index | FTSE 100 index |
| section | asset management | modes | Mining |
| Share the price | 258.82 p | 89.02 p | 6288 p |
| The highest level in 52 weeks | 287.9 p | 119.1 p | 6406 p |
| The lowest level in 52 weeks | 191.37p | 53.97p | 4,424.5 p |
| 12-month change | -4.7% | -22.6% | +10.4% |
| Market value | £15.5bn | 3.6 billion pounds sterling | £105.5bn |
| share price ratio | 7.6 | 7.6 | 7.0 |
| Dividend return | 13.1% | 13.2% | 14.3% |
| profit return | 9.2% | 5.6% | 8.4% |
| Dividend cover | 1.4 | 2.3 | 1.7 |
Within this table full of numbers, my main one is the row showing each company’s dividend yield. This is the cash return each share pays over the course of one year. This ranges from 5.6% per annum in broadcaster ITV to a sweet 9.2% per annum in the insurance company and asset manager Legal and public group.
The second important number for me is the earnings cap. This shows how many times a company’s earnings are covered by its earnings per share — the higher, the better. In my table, the dividend cover ranges from a modest 1.4 times at L&G to a stronger 2.3 times at ITV.
For the record, I’d be happy to buy more shares of these three companies at current price levels. But with dark clouds gathering over the UK economy, I am bracing for a recession in 2023-24. This may cause the company’s profits to decline in the short term. So, rather than buying more of these three stocks right now, I’m going to look for other deals elsewhere in the FTSE 100!
