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Shares in companies that pay dividends to investors can be a great source of passive income. But not all of them are the same and there are a few different approaches available.
Investors aiming for a particular target – for example, £1,000 a month – can choose between a few different strategies. And they all have different strengths and weaknesses.
High yields
One approach involves focusing on companies with high dividend yields. In some cases – Legal & General being a good example – this can be as high as 8%.
The basic strategy is to start off with an initial investment and reinvest the returns to generate growth. By using dividends to buy more shares, an investor can earn more income over time.
Investors taking this approach need to be wary of taxes. With UK shares, there is stamp duty to pay attention to and distributions from US companies are subject to withholding taxes.
Nonetheless, this can be a respectable approach for investors. And someone who invests £20,000 and reinvests dividends at 8% a year could be earning £1,000 a month within 25 years.
Dividend growth
The other approach is to focus on shares in companies that can grow and increase their returns by themselves. Rightmove is a good example of this type of stock.
The dividend yield is currently 2%, but the firm has more than doubled its dividend in the last 10 years. So investors are getting more cash back without having to reinvest their returns.
Of course, there’s no rule saying anyone can’t also reinvest their dividends to compound their returns at a higher rate. And in Rightmove’s case, that can lead to annual growth of 11%.
Over time, this can be a powerful force. So investors looking for passive income shouldn’t just write off a stock because it has a low dividend yield.
A stock to consider
In general, investors have to make a choice between cash today and future growth prospects. But Games Workshop (LSE:GAW) is a stock that I think might offer investors both benefits.
The current dividend yield is 2.29%, which is below the FTSE 100 average. But its growth over the last 10 years has been spectacular and I think there’s more to come.
The company’s Warhammer franchise has been such a success that it has grown its dividend by an average of 30% a year over the last decade. That’s an extremely impressive rate.
If it keeps going like that, a £20,000 investment today will return £1,000 a month in dividends within 15 years. So I think it’s clearly worth taking a look at even with a low starting yield.
Dividend investing
Investors need to keep in mind that dividends are never guaranteed. Games Workshop’s ability to keep increasing its returns depends on it continuing to grow its sales and profits.
A recession is always a potential threat for a company that makes products that people want rather than need. And UK unemployment has been rising recently.
The firm’s strong intellectual property, though, allows it to return cash to shareholders without compromising its core asset. That’s why I think it’s one for investors to take a look at.
