Owning dividend shares can be a good way of generating some passive income. In fact, that is one of the things I use my Stocks and Shares ISA for.
Below is an example of how I would aim to earn £50 each month in dividends by investing £10,000 in a Stocks and Shares ISA.
Dividend shares and passive income
Targeting £50 a month adds up to £600 each year. If I invested £10,000 in shares with an average dividend yield of 6% or higher I ought be able to achieve that.
Depending on how the dividends were timed, I might not get the money regularly each month, but rather a monthly average of £50 over the course of the year.
Focus on quality not dividend yield
Dividends rely on profits, so it could be a costly mistake if I invested in a high-yielding share without understanding a company’s business model or how likely it seems to make profits in future that could fund dividends.
So I would try to find businesses operating in markets with resilient customer demand. If they had some advantage that could help them make profits in future – like a large installed customer base or unique technology – I would consider them for my ISA.
Shares to buy now
Based on that approach, at the moment I would split my £10,000 evenly across the following five companies.
Insurer Legal & General has a distinctive logo, long history, and wide customer base. It has set out plans to keep raising dividends in coming years. Dividends are never guaranteed and one risk I see with Legal & General is an economic downturn leading to customers investing less, hurting revenues. But the company’s strengths attract me and it yields 7.4%.
For similar reasons, I would also buy the firm’s 10.8%-yielding rival Direct Line. Such a high yield can signal risk. I am concerned that renewal pricing rules introduced this year could hurt the company’s profit margins. But I think its strong brand, proven underwriting expertise, and ongoing customer demand for insurance should help the company.
I would buy tobacco manufacturer British American Tobacco for my Stocks and Shares ISA. The owner of brands including Lucky Strikes is a cash generation machine. That helps support a large dividend, with the shares currently yielding 6.3%. Falling cigarette volumes in many markets pose a risk to revenues. I think the company can use its sales network and brand portfolio to build its non-cigarette revenues in coming years.
I also like the long-term prospects at Tesco. People will always need to buy food. Increased competition from discounters may put pressure on margins but the market leader has a strong position and yields 4.2%.
My final choice would be vending booth operator Photo-Me. It has seen demand return strongly in most markets, although ongoing lockdowns in Asia remain a drag on profits. The company’s launderette business looks promising to me. The dividend yield is 3.8% but I think strong cash generation could enable a higher dividend in future, as happened before the pandemic.
Dividends from my Stocks and Shares ISA
With an average yield of 6.5%, spreading £10,000 in my Stocks and Shares ISA across those five choices should hopefully generate annual passive income of £650.
That comes out at around £54 each month in dividend income.