Dividend shares can be an excellent way to earn extra income, in my opinion. Some of the best stocks provide steady and reliable cash flow to investors.
Currently, the FTSE 100 offers a dividend yield of around 3.5%. Given rising interest rates, that doesn’t strike me as particularly high. But as it’s an average, it masks several high-dividend shares from which I could pick.
For instance, 16 FTSE 100 shares yield more than 6%. That’s much better and more in line with what I would consider.
It’s not enough to just pick shares with the largest yields though. There are several other considerations to take into account.
Factors to consider
As I’m looking for a reliable second income, I want my dividend shares to have a reasonable track record. Those that have been paying dividends to shareholders for more than a decade give me more comfort than those that have just started.
Next, I’d look for stable business models. I want these companies to have survived a long time. That often means they have strong brands, or business models that are difficult to replicate.
Finally, I’d ensure these companies can afford to pay income to shareholders from their earnings. One measure to calculate this is called dividend cover. Ideally, the best dividend stocks have cover of at least 1.5, in my opinion.
Right now, several companies meet my criteria. But with £3,000 to invest, I’d narrow down my list and split my funds across a selection of three.
At the top of my list is British American Tobacco. Its share price has drifted lower over the past month, which has boosted its dividend yield to 7%. That’s an opportunity and if I didn’t already own these shares, I’d buy them today.
With nearly three decades of dividend history, it offers investors a reliable income stream. Its brands are well-known, which offers a competitive advantage.
Bear in mind that the traditional cigarette market is a declining industry in developed countries. But the group is investing in new vaping products, and it’s encouraging to see that this has started to drive growth.
If I had some spare funds, I’d buy Legal & General Group. This financial services business offers a 7.2% yield and has been distributing income to shareholders for more than 30 years.
Over the past decade, investors would have achieved a 10% annual return. That’s enough to turn £3,000 into £7,781 over that period. One thing to note is that most of those gains would have been due to its chunky dividend.
As many disclaimers note, past performance is no guarantee to future results. That said, with a long-established brand and several diversified businesses within the group, I reckon Legal & General should continue to thrive over time.
Lastly, if I had some spare cash, I’d buy shares in Taylor Wimpey. It might sound like an odd time to be investing in a housebuilder. The housing market looks to be cooling, and higher mortgage rates could put pressure on buyers.
The Bank of England is expected to raise interest rates further over the coming months, but with inflation now falling, rate hikes thereafter could be limited.
This could be an opportunity to buy a quality business with a solid 7% yield.
The post Here’s how I’d invest £3,000 in dividend shares to earn a second income appeared first on The Motley Fool UK.
Harshil Patel has positions in British American Tobacco P.l.c. The Motley Fool UK has recommended British American Tobacco P.l.c. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2023