Investing early in top-notch dividend stocks is a proven method for establishing a chunky long-term passive income. After all, companies that continuously grow their cash flows also typically increase their payouts to shareholders. And in some cases, this trend is maintained for decades, pushing an initially modest yield to gargantuan levels.
This is how billionaire investor Warren Buffett now earns more than a 50% yield on his investment in Coca-Cola. And there are plenty of companies in the UK with the potential to achieve similar returns.
So what should investors be looking out for? And what’s one of the most promising income opportunities on the London Stock Exchange today? Let’s explore.
Finding future Dividend Aristocrats
The UK stock market is already home to a range of dividend stocks that have been hiking payouts for decades. However, while these can be a popular destination of capital, most only grow dividends by tiny amounts to maintain their status rather than meaningfully bolster shareholder wealth.
Instead, investors should focus less on the dividend track record and more on what’s going on with free cash flow. This is the money left over after a firm has paid all of its operating expenses and capital investments. Growth stocks typically retain this income and let it accumulate as cash on the balance sheet. However, income stocks instead use it to pay dividends to investors.
By analysing the cash-generative properties of a business model, investors can judge how easily a company can generate organic free cash flow. It also helps in revealing where the weak spots are that could jeopardise this cash generation process.
Don’t forget dividends can get cut if cash flow is disrupted. And such events can have a nasty knock-on effect on the share price, sending it firmly in the wrong direction.
But if a business has a robust long-term strategy and an in-demand product/service that’s not easily disrupted, then investors may be on to a winner.
A golden opportunity?
Out of all the income stocks in my existing portfolio, Londonmetric Property (LSE:LMP) currently jumps out at me. The firm owns a portfolio of commercial real estate primarily in the form of logistic warehouses leased to e-commerce and other retail enterprises.
In the face of rising interest rates, property values have unsurprisingly dropped considerably, taking the Londonmetric share price with it. However, with an average lease duration of 13 years and an occupancy of 99% as of September 2023, the firm’s free cash flow has kept growing.
In other words, despite what the share price suggests, dividends continue to look rock-solid. Furthermore, management recently unveiled its intention to acquire one of its top competitors, LXi. Assuming this deal’s successful, that would make the firm the second-largest publicly-traded commercial real estate landlord in the UK.
Of course, as with all acquisitions, this planned merger comes with several risks. The most notable revolves around underperformance. Should a significant chunk of acquired properties fail to retain or attract quality tenants, cash flows may start to dry up.
With eight years of dividend hikes already under its belt, Londonmetric is well on its way to eventually becoming a dividend aristocrat. And with the e-commerce sector only becoming more prominent, this upward trend looks set to continue, in my opinion.
