With the cost-of-living crisis increasing pressure on households, the importance of earning a second income’s rising rapidly. Luckily, dividend shares offer a potential solution to this problem, allowing focused investors to earn impressive long-term passive income.
So how does investing in dividend shares work? What are the risks? And which dividend stocks should investors consider buying in 2025?
Dividends explained
Not all businesses are high-flying enterprises. The London Stock Exchange is home to many mature businesses whose explosive growth days are now in the rear-view mirror. However, with the strong demand for their products and services, their cash flows remain robust. As such, with no other use of capital internally, management teams are returning a large chunk of this cash back to shareholders – the owners.
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Typically, dividend payments come every quarter, although this frequency can be different depending on the business and its cash flow timings. However, most companies like to keep payment timing relatively consistent. And investors can leverage that to establish a reliable and predictable income stream.
Due to their maturity, investing in dividend shares is often considered to be a relatively low-risk strategy. And historically, that’s certainly proven to be true in terms of lower share price volatility. However, even the biggest and most stable enterprises have their fair share of threats to contend with.
If cash flows become disrupted, dividends can often find themselves under pressure. And if market conditions become too adverse, shareholders may see their payouts get cut or even outright cancelled. As such, the second income generated by an investment portfolio can take a hit on relatively short notice.
Luckily, such risks can be managed with prudent market monitoring and portfolio diversification.
Best income stocks to buy now?
There are a lot of UK dividend shares to pick from. However, not all of them offer the best value or long-term income potential. And depending on the risk tolerance and time horizon of an investor, the best dividend shares to buy can vary, depending on the individual.
That said, there continues to be some interesting opportunities within the real estate sector right now. LondonMetric Property‘s (LSE:LMP) one such business. It’s currently digesting its recent large acquisition of LXi. However, despite generating impressive free cash flow and offering a 6% yield, shares continue to trade at a discounted valuation.
Higher interest rates have wreaked havoc on property prices, even in the commercial sector where LondonMetric operates. And with the book value of its assets marked down, shares are still trading at a forward price-to-earnings ratio of 13.9.
To be fair, weakened asset prices can be problematic. Suppose management suddenly needs to sell properties to raise capital. In that case, it will likely have to do it at a discount, given the weakness in the commercial real estate market. And the group’s £2.2bn of debt does add pressure to the bottom line, due to higher interest rates.
However, despite these handicaps, demand from tenants and occupancy remains strong, as do cash flows. That’s why LondonMetric Property’s already in my income portfolio, and I feel other investors may want to consider it for theirs.
