I believe developing a profitable passive income strategy is the best way to make money while I sleep. Some people spend a lot of time and money building side hustles to generate a second income, but I’d rather focus on investing in high-yield dividend stocks.
Building a second income of £10,000 a year won’t happen overnight. First, I need savings put aside to get started. Then, I must find a well-established company with a reliable track record of paying high-yield dividends. After my initial investment, I will keep making monthly contributions to increase my investment and maximise returns. Finally, I will compound my investment by adopting a dividend reinvestment plan (DRIP).
Many UK companies pay out annual dividends of between 5% and 10% to shareholders in two or four increments a year. For example, if I have 100 shares in a company with a 5% dividend yield, I would accrue an extra five shares throughout the year. However, dividend yields fluctuate and a company can choose to not pay them at any time, so profits aren’t guaranteed.
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The company I’m looking at
Imperial Brands (LSE:IMB) has a share price of £18.50 and pays out a dividend yield of 7.9%. I expect its share price to increase by an average of 12% annually, and its dividend yield to reach 9.1% in three years. By my calculations, if I buy 700 shares combined with monthly contributions and reinvested dividends, I could achieve my goal.
For the initial 700 shares, I’d spend £12,950 of savings. I’d then invest a further £200 a month for the next 10 years.
I would compound my gains with a dividend reinvestment plan that puts my payouts back into my portfolio.
In 10 years, I estimate my investment could grow to £145,000. This would pay me out annual dividends worth around £10,000. That equates to a sizeable second income of £833 a month.
But will it work?
Despite high debt, I think Imperial Brands is a reliable company with strong financials and a history of consistent growth. Its share price declined between 2017 and 2020 but made an impressive recovery during the pandemic. The group has a progressive dividend policy that saw its dividend yield increase by 4% between 2022 and 2023. This is expected to increase even further in the coming years.
My only concern is a slightly volatile history of dividend payments that equates to a dividend payout ratio just below 60%. That means I could miss out on two in every five dividend payments if the ratio doesn’t improve.
Still, it has sufficient earnings to cover dividends and a yield that’s in the top 25% of dividend payers in the UK market. That makes Imperial Brands a strong contender as the stock of choice for my passive income strategy.
