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When I first started building my income portfolio, I was disappointed. I’ve found it difficult to maintain average yields, and I often get stuck holding bad stocks after a company cuts dividends.
I felt it would take forever to save enough to make meaningful gains. And I was impatient. So I made a commitment to reduce my daily expenses by at least £10, saving £300 a month to invest.
Then I started picking better stocks with lower yields, but more sustainable. I have found that by making good decisions, I can save an average yield of about 7%.
It calculates returns
By my calculations, I would need around £171,000 to bring in £12,000 a year in dividends – my target. Divided by £10 a day (£3,650 a year), that would have taken me 46 years to save. Enough for a 20 year old, but too long for my needs.
Fortunately, by reinvesting the profits and using the miracle of compounding returns, I can cut this time in half!
I calculated that if my rate holds, I could reach around £170,000 in 21 years. That is enough to fulfill my goal before retirement.
So what are these ‘sustainable’ dividend stocks?
Identifying reliable dividend stocks
For investors interested in this strategy, here is an example of how I identify sustainable dividend stocks.
First, I look for stocks with 10 years or more of payouts, a payout ratio of 50%-90%, and adequate cash cover. Importantly, I look at the balance sheet to make sure the debt is manageable. High debts are often the first reason that dividends are cut.
I FTSE 250 price comparison site The MONY team (LSE: MONY) is a good example. It has a 6.7% yield, an 81% payout ratio, and 18 years of uninterrupted payments. The balance sheet is very healthy, with £229m of cash far outweighing £45m of debt.
It’s also highly profitable, with a return on equity (ROE) of 37.2% – a rate typically seen only in high-income growth stocks. With steady earnings growth of around 8% year-on-year, the 186p share price now looks to be worth 45%, based on future cash flow estimates.
But the company operates in a crowded, highly competitive price comparison market where differentiation is a challenge. This may be one reason why the share price has fallen by 29% in the last five years. However, the stock grew by 314% in the 10 years before Covid, suggesting that it does well in times of economic prosperity.
Final thoughts
With consumer confidence at an eight-month high and GDP expected to increase by 1.4% of GDP, MONY Group could benefit. Low interest rates increase household spending power, which drives demand for its financial products. Its lean performance positions it well to benefit from renewed consumer activity.
Despite the macroeconomic uncertainty, I think it’s still worth considering an income portfolio for startups. However, it should only be included as part of a larger diversified portfolio that includes between 10 and 20 holdings.
While it’s good practice to focus on industries you know, it’s equally important to mitigate sector-specific risk by incorporating some outside factors. Investors can find a number of other income shares in the UK market that offer similar sustainable characteristics.
