Income stocks form the core part of my portfolio. These stocks provide me with a regular, albeit not guaranteed, income in the form of dividends.
So why do I think now is a good time to buy more income stocks?
Correction? What correction?
Some people might ask what correction? The FTSE 100 is actually up marginally over the past 12 months. But the reality is that the index has been dragged upwards by surging resource stocks while much of the index is down.
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For example, Shell, the biggest stock on the index by market value, is up 40% over 12 months. The index has a disproportionate number of resource-focus stocks.
The FTSE 250 is down 20%, and this is more reflective of the health of UK stocks. Sectors such as retail, housebuilding, banking and travel are still trading at considerable discounts.
This is especially the case for stocks that are UK-focused, as many parts of the global economy are performing better than here.
Dividend yields
The dividend yield is a financial ratio that tells me the percentage of a company’s share price that it pays out in dividends each year. And when share prices fall, dividend yields go upwards — assuming dividend payments remain constant. Naturally, it works the other way too.
So by investing when share prices fall, I can lock in a higher dividend yield for the long run.
It’s also important to remember that stock market corrections don’t happen all that often, although the last few years has been somewhat of an exception.
Personally, after the shocks of the pandemic and Russia’s invasion of Ukraine — and the associated economic fallout — I’m buying now as I’m conscious that there might not another opportunity like this for some time.
Sustainable yields
With share prices falling across multiple sectors, we’ve seen some really big yields this year. But some aren’t sustainable.
For example, Persimmon‘s yield reached 20% in the autumn as the share price halved. However, even in 2021, the firm’s dividend coverage ratio indicated it only just has enough income to pay its shareholders. So as the operating environment grew less favourable this autumn, Persimmon cut its dividends.
The dividend coverage ratio (DCR) is a useful tool to assess the sustainability of a yield. A DCR above two is healthy, anything around one is concerning.
For me, some of the best and most sustainable yields appear to be in the financial services sector right now. I’ve recently bought shares in Phoenix Group and Direct Line Group.
The former offers a 7.88% dividend yield and the firm is on track for a strong year. The insurer said in an autumn update that it expects to deliver around £1.2bn of incremental, organic new business long-term cash generation in 2022.
The latter offers a huge 10% yield, and after a challenging start to 2022, is now back to writing at target margins.
