I’m a big believer in passive income — the income I earn without working for it. Of the dozens of types, my favourite is the free cash I get from share dividends.
Three big problems with dividends
However, I have three main problems with share dividends. The first is that most UK-listed companies don’t pay any cash dividends. This is particularly the case with smaller companies, which invest their cash flow to drive future growth. I get around this problem by dividend-hunting in the FTSE 100. Within this index of big businesses, all but a handful of blue-chip firms pay regular dividends.
My second problem is that future dividends aren’t guaranteed, so they can be cut or cancelled at any time. For example, during the 2020 Covid-19 crisis, scores of UK companies reduced or withdrew their cash payouts without notice.
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Third, even the largest firms sometimes drop their dividends during lean years. But my 36 years of investing have shown that dividends accounted for perhaps half of my long-term returns from shares. So I faithfully stick to my strategy of being a value/dividend/income investor, come what may.
Cheap income shares
I create a more reliable stream of dividend income through diversification. By diversifying my share portfolio, I spread my money across lots of different baskets by owning, say, 20+ different stocks. This also adds balance and ballast to my portfolio during periodic market meltdowns.
By investing in a wide range of quality companies at reasonable prices, my wife and I have built enough passive income to retire today. But as we both enjoy our jobs, we keep on working.
Even so, we’re always looking for new shares to add extra dividend income to our family portfolio. Here are three cheap stocks that we bought last summer for their delicious dividends:
| Company | Legal & General Group | ITV | Rio Tinto |
| Index | FTSE 100 | FTSE 250 | FTSE 100 |
| Sector | Asset management | Media | Mining |
| Share price | 258.82p | 89.02p | 6,288p |
| 52-week high | 287.9p | 119.1p | 6,406p |
| 52-week low | 191.37p | 53.97p | 4,424.5p |
| 12-month change | -4.7% | -22.6% | +10.4% |
| Market value | £15.5bn | £3.6bn | £105.5bn |
| Price/earnings ratio | 7.6 | 7.6 | 7.0 |
| Earnings yield | 13.1% | 13.2% | 14.3% |
| Dividend yield | 9.2% | 5.6% | 8.4% |
| Dividend cover | 1.4 | 2.3 | 1.7 |
Within this table packed with numbers, my key figure is the row showing each company’s dividend yield. This is the cash yield that each share pays out over the course of one year. These range from 5.6% a year at broadcaster ITV to a tasty 9.2% a year at insurer and asset manager Legal & General Group.
The second important figure for me is the dividend cover. This shows how many times a company’s dividend is covered by its earnings per share — the higher, the better. In my table, 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 gladly buy more shares of these three companies at current price levels. But with dark clouds gathering over the UK economy, I’m bracing for a recession in 2023-24. This might bring down company earnings in the short term. So, rather than buy more of these three stocks right now, I will hunt for other bargains elsewhere in the FTSE 100!
