The FTSE 100 is a good place to hunt for undervalued stocks with strong yields — that’s my opinion, and it’s why FTSE 100 stocks are well represented in my portfolio.
Naturally, if I want to create a second income stream, I need to invest in dividend-paying stocks. Let’s say I’m aiming for £5,000 a year. Then I’d either need £50,000 invested in stocks paying 10%, which is possibly risky, or £100,000 invested in stocks averaging 5%. That’s ‘safer’ but requires more cash.
Instead, I’d compromise, and aim to average 7% on £70,000. That’s certainly achievable, although it still requires considerable starting capital.
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Reaching £70,000
Not everyone has £70,000 lying around. So, what I could do is start with a smaller sum, say £20,000, and invest that in stocks paying 7% for 10 years. Every year I’d reinvest my dividends and every month I’d contribute around £170.
After 10 years, I’d have £70,000.
This is a compound returns strategy. It’s worth noting that the longer I keep doing this, the more money I should have (as long as my investment don’t lose value, which is always a possibility). Growth is exponential. After 30 years of the strategy, I’d have £380,000.
Creating a second income stream
If I’m trying to get the biggest and most sustainable yield, I’d spread my investments across multiple stocks. I’d likely invest in quite a few companies. But today I’m exploring just three FTSE 100 stocks that I’d use to create a second revenue stream.
Phoenix Group Holdings is a savings and retirement business that offers an 8% yield and has dividend coverage of 1.7. Impressively, it has 13 years of consecutive payments and investors benefit from consistent dividend growth. It’s certainly not the most exciting of businesses — share price growth reflects this — but the insurer expects to deliver around £1.2bn of incremental, organic new business cash generation in 2022.
Next, I’d buy Legal & General. The firm, as part of a five-year plan announced in 2020, is aiming to grow the dividend at low-to-mid single-digit percentage every year. In 2021, it raised the annual dividend by 5%, and it did the same with the 2022 interim dividend.
Legal & General is a well-run company and I’m not expecting it to have to cut its dividends like Direct Line. Dividend coverage was 1.85 in 2021, and I don’t expect that figure to come under too much pressure going forward.
I own both of these stocks — and recently topped up on both — but I don’t own my third pick, Rio Tinto. The miner has performed extremely well in recent months, and I want to buy at a slightly better entry point than we’re seeing now. However, the long-term prospects for this dividend-paying miner are positive.
The industry can be hampered by many things, including industrial action and bad weather. However, metals are increasingly in demand in this age of electrification and infrastructure development. For example, Citi analysts contend that copper demand will rise by 7m tonnes between 2021 and 2030.
Rio offers a 6% yield. So collectively, these three firms could provide me with a 7% average yield. That’s enough to turn £70k into £5k a year.
