The question I get asked a lot is if it is feasible to use dividend paying stock as a primary income stream. This is a rather tricky question and you would have to determine exactly what amount of income you would like. In this post, I will aim to analyse if it is really possible to earn good income from share dividends for the average person.
Dividends and the ratios to look for?
In order to answer this question, we first need to look at what dividends are. Dividends are the share of company profits that are paid out to the owners/shareholders.
A company has 2 options it can take in relation to its profits, it can either reinvest the money back into the business (leading to a higher amount of dividend in the future) or it could pay it out as dividends. Most companies chose some combination of this two. When buying shares or into a fund, it is important to get dividend units as opposed to accumulation if you want the dividends to be paid out to your bank account. As a rule of thumb, most established businesses that are in the later stage of their growth or the maturity stage of their cycle tend to pay dividends.
There are 2 important ratios to look at when considering dividend paying stock:
- Dividend Per Share (DPS). This is the amount in money terms each share receives. For example, if £1 is paid out each year per share of a certain company, then that would be the dividend per share
- Dividend yield is the % of the current market price that is paid in dividends. Dividend yield can be a better figure to look at then DPS as it gives a better indication of the dividend income that can be derived from a stock. Stock X may be paying out the same as Stock Y, but if stock X is trading at £100 and stock Y at £50, there is a material difference in dividend yield. Company Y will have a dividend yield of 2% whilst stock X will have a yield of 1%.
Now we’ve looked at what dividends are, we can look at real market data to see if it is possible to earn a primary income stream using dividends. We will take the income we want per year as £30, 000 as this is close to the average salary in the U.K.
Vodafone PLC (VOD)
Firstly, let us look at Vodofone PLC. Vodafone is one of the top performing blue chip firms on FTSE 100 and has consistently produced dividends every year for its share holders. It is also one of the established companies on the FTSE whose yield is on the higher side thus making it a good candidate for this example.
- Income Wanted : £30, 000
- Share Price: 221.4p
- Annual Dividend Paid: 10.3p
- Dividend yield: 4.65%
- Shares Needed: 291,263
- Investment Needed: £644,854.37
As can be seen by the figures above, the current share price of Vodafone is 221.4p. Over the last 5 years, it has paid a dividend on average of 10.3p. We have taken average dividends for the past 5 years as this gives a sound basis for analyses and takes fluctuations of dividends into consideration. As can be seen, the dividend yield is 4.65%. This may sound low but remember that companies usually take a balanced approach to dividends. They are not going to pay out all their earnings in dividends so investors should expect the additional earnings to be re-invested and be reflected in higher stock prices over time.
So if you need income of £30,000 a year, you would need approximately 291,263 shares in Vodafone. The cost of acquiring this number of shares at current market price is just over£644,854 as seen. This is an extraordinarily high amount you need to invest in order replicate an income similar to your salary of £30, 000.
Most of the established companies on the FTSE that consistently payout dividends have yields of about 4% – 5% so chances are, if you are looking to invest in a different company and looking to get the same income, you will still have to stump up over £600,000.
As the average dividend yield is about 4% – 5% as mentioned, it is possible to get stocks of a higher yield for good companies on the FTSE 100 for a yield of greater than 5%.2 examples that come to mind at this moment in time is Centrica and Sainsbury’s as their prices have come down significantly as a result of the supermarket and energy crises. The yields for these 2 companies look great on paper at the moment (but dividend payouts might reduce proportionately over the next couple of years). I have chosen these 2 companies in particular as they both have strong balance sheet and I think they will be the company that best withstand the current turmoil in their respective industries.
Centrica PLC (CNA)
- Income Wanted : £30, 000
- Share Price: 275.70p
- Annual Dividend Paid: 15.18p
- Dividend yield: 5.50%
- Shares Needed: 197,629
- Investment Needed: £544863.15
Firstly, let’s have a look at Centrica. At current market price, it has a higher dividend yield than Vodafone. So in order to achieve your income of £30, 000 a year, you need to buy 197,629 shares which would cost £588,863. Centrica shares can be seen to be giving better investor value at the moment compared to Vodafone.
J Sainsbury PLC (SBRY)
- Income Wanted : £30, 000
- Share Price: 226.1p
- Annual Dividend Paid: 15.88p
- Dividend yield: 7.02%
- Shares Needed: 188,917
- Investment Needed: £427141.06
Sainbury’s, like Centrica, also has an undervalued share price at the moment. Sainsbury’s shares currently have the best dividend yield of the 3 companies with a yield of 7.02%. So in order to generate income of £30, 000 a year, you will need to buy 188, 917 shares in Sainsbury’s at a cost of £427,141.00. This figure is still very high and above most peoples portfolio sizes.
As you can see from the above, dividend yield can be relatively low but payout ratios are still better than interest rates at the moment. A low dividend yield is common across most stock markets as a high dividend yield means that the company is not re-investing and of their profits into their operations. This can have a negative impact on their growth potential and their stock price in the long-term. It is also worth noting that the average dividend pay-out in the U.K is higher than that of any of the U.S indexes, and that is perhaps why the U.S indexes have historically grown faster than the FTSE.
Thus, we can safely say that it takes a large investment to get any sort of material income from dividend paying stocks. With most people having investments in the stock markets of far less than the figures stated above, dividend’s aren’t the quickest way of building wealth. But if you continually decide to re-invest over time, you may be able to eventually live off dividend income. Dividend paying stocks could be genius for your portfolio – not for income if you are still starting off – but because they multiply. All you need to do is buy dividend paying stocks from good solid businesses and enroll in the Divided Reinvestment program in order to let your holdings grow. Who knows, you may even be able to live off dividend income in the future.