I’m currently searching for dividend stocks to add to my portfolio in order to generate passive income streams. I particularly like the look of two UK stocks with exceptionally high dividend yields, namely FTSE 100 tobacco giant, Imperial Brands (LSE: IMB), and FTSE 250 insurer, Direct Line Insurance Group (LSE: DLG).
With a spare £500, I’d buy shares in both companies today — here’s why.
Imperial stock: 8.68% dividend yield
Imperial Brands has the third-highest dividend yield in the FTSE 100 index, behind Rio Tinto and Persimmon. The Imperial share price has increased by 9% over the past year. The stock currently trades at a reasonable price-to-earnings ratio of 5.39.
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Tobacco stocks typically carry high dividend yields due to low capital expenditure and high profit margins. Rather than reinvesting their impressive cash flows into the business, they often distribute regular dividends to shareholders.
There are potential moral concerns surrounding investing in Imperial stock, given the adverse health implications for consumers of its products. Moreover, creating a smoke-free generation has been a longstanding goal of the Department of Health.
The UK may one day follow in New Zealand’s footsteps. The Pacific country recently announced a ban on anyone born after 2008 from purchasing cigarettes. As UK sales make up 9% of the group’s net revenue, this could seriously threaten the Imperial Brands share price, despite efforts to diversify away from combustible tobacco with a focus on vapour and oral nicotine products.
This wouldn’t dissuade me from buying Imperial stock, however. I see the fact that it has one of the highest dividend yields in the FTSE 100 as reasonable compensation for the long-term risks.
The company also posted encouraging financial results for 2021. Operating profit increased by 15.2% and basic earnings per share were up by 89.5% on 2020. Crucially, Imperial’s dividend increased by 1% to 139.08p per share in line with the company’s progressive dividend policy.
Direct Line stock: 8.2% dividend yield
Direct Line is one of the top ten FTSE 250 stocks when it comes to dividend yields. The Direct Line share price is down 10% over the past year. I see this as an attractive entry point to take a position in the insurer.
At £314.8m, motor insurance produced 54% of Direct Line’s operating profit for 2021. I believe consumer demand for its insurance products will remain strong, despite rising inflation and squeezed household budgets.
After all, driving is an essential feature of many people’s lives and car insurance is mandated by legislation. Additionally, Direct Line is a familiar household brand thanks to the company’s advertising campaigns.
The introduction of new FCA pricing rules in January has caused uncertainty in the insurance market, leading to hikes in premiums. Direct Line acknowledges this risk in its financial results and the company has conducted scenario testing to mitigate this.
Considering its downtrodden share price and a dividend yield over 8%, I’d buy shares in Direct Line now.
Dividend yields for passive income
If I invested £500 evenly between the two stocks, I’d expect to receive £42.20 a year in passive income at current dividend yields.
There is speculation that Chancellor Rishi Sunak may cut the current £2,000 dividend allowance in the Spring Statement. To protect my total dividend income from future tax changes, I’d buy these equities in a Stocks and Shares ISA before the upcoming ISA deadline on 5 April.
