With the Bank of England base rate at 5.25% and the FTSE 100 average dividend yield at 3.76%, it might seem far-fetched to think about making 10% a year from dividends. Granted, this level of passive income doesn’t come without a more elevated level of risk. Yet that doesn’t mean it’s impossible for me to achieve.
Why high yields help me
In the FTSE 100 and FTSE 250, there are seven stocks that currently have a dividend yield of 10% or greater. This doesn’t give me a huge range to pick from, but it’s enough for me to start building a portfolio.
The benefit of selecting high-yielding stocks can be large. For example, let’s say I picked a stock with the index average yield of 3.76%. I’d have to hold this stock for over two and a half years to equate to the same yield as I would in just one year from a stock offering 10%.
Given that I’m keen to compound my money fast for the long term, there’s another benefit here. I can take the generous pay out and invest it back via buying more shares. Simply put, a higher-yielding stock enables me to compound my rate of growth quicker than one with a lower yield.
One for the hit list
A good example of a stock I’d buy if I was targeting this yield is NextEnergy Solar Fund (LSE:NESF). The FTSE 250 firm has a current dividend yield of 11.06%.
Part of the rise in the yield has been the 30% drop in the share price over the past year. Rising interest rates mean that it’s more expensive to take out debt to finance new infrastructure projects. Further, the fund is selling some assets, which can add uncertainty due to it being a lengthy process.
However, I think this move lower has been overdone. I don’t see any major problems with the firm going forward. In fact, the share price has fallen far more than the net asset value (NAV) of the funds assets should imply. At the last estimation, the stock trades at a 31% discount to the NAV.
When I look through the latest presentation from last autumn, I feel confident the dividend isn’t under pressure. For example, the dividend cover ratio is 1.8 times, comfortably above the level of one. It has a total gearing of 46.4%. Again, this is low enough in my view for debt not to be a problem going forward.
Risks to remember
I have to flag up that targeting such a high overall yield does carry risks. Given the small pool of potential companies that fit the bill, it could make my portfolio overly concentrated with just a few stocks. If something goes wrong, it could really impact the overall return.
Another point is that sometimes a high yield isn’t sustainable. If the company’s in trouble and the share price keeps falling, the yield might look high. But if the firm then cuts the dividend to preserve cash flow, my yield could suddenly be cut.
Ultimately, I believe I can target a 10% yield. Other investors can do the same, but it’s not a low-risk strategy.
