When building my investment portfolio, I’ve always been keen to include a selection of income shares. The goal of these holdings is to generate a consistent passive income that can compound considerably over the years. This acts as a good form of diversification from my portfolio’s expected growth and value investments.
In the past, I focused on picking companies that offer the highest dividend. I thought this was the only way to build a good income portfolio. However, on further consideration, I’ve found that the most important factor is a high level of forecast dividend growth. This will help to amplify the compounding impact of dividends and steadily increase the passive income from these investments.
For this reason, I’ve decided to consider a new approach to income investing. I now look at companies that have paid and grown their dividends for many years. These companies may only offer a yield of 2%-3% in the current year. However, the goal of this approach is for this dividend yield to increase gradually over the duration of my investment.
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New opportunity
A company on my list is Morgan Advanced Materials (LSE: MGAM), a UK-based manufacturer of specialised materials. The share price has struggled over the last year, falling 32.2%. It is now down over 40% from its peak in 2021. Consequently, the price-to-earnings (P/E) ratio is now nine and is forecast to hit just 8.1 by next year.
However, the dividend yield, which is currently 3.7%, drew my attention to the company. This has been paid consistently for the last 17 years and has grown for the last two. In addition, the dividend is forecast to grow by almost 12%, hitting 4.2% for 2023. This is very encouraging, especially given the dividend cover ratio. The ratio is forecast to remain at 3, indicating this new yield can be comfortably covered by earnings per share (EPS).
Strong fundamentals
Morgan’s underlying fundamentals are strong, with good profit margins, efficient earnings generation from capital, and reasonably high cash conversion. Earnings forecasts are also encouraging, with turnover expected to grow by 7.6% and EPS by 11.3%. These are both considerably above the three-year average and help to demonstrate future dividend affordability.
But it’s important to note that the company’s debt levels are slightly higher than I typically like, at 32.2% of market capitalisation. This is further increased by the pension deficit hitting 14.8% of market capitalisation, which will put pressure on future dividend payments. Furthermore, the dividend was reduced in 2020, and although it has returned to growth, this could indicate that future dividend cuts could occur.
Nonetheless, I think that accessing such a consistent and growing dividend yield is a great opportunity. Therefore, I’m keen to add Morgan Advanced Materials to my 2023 portfolio once I get the necessary funds.
