The FTSE 250 is the UK’s mid-cap index and it’s home to many shares that offer both growth and income.
Smaller companies can often grow faster than many of the slow-moving giants found in the FTSE 100. In referring to this point, popular small-cap investor Jim Slater once said: “Elephants don’t gallop”.
One factor that’s infrequently mentioned are the dividend yields available in the FTSE 250. Although the average yield for this index is just 3%, there are many shares that offer much more.
Reliable dividend stocks
Several stocks even offer double-digit yields. But it’s important to note that extremely high yields might not be reliable. Bear in mind there’s always a chance that the payout is cut, resulting in less dividend income.
That’s why I only want to invest in reliable and affordable dividend shares.
To measure reliability, I’d look at how many years a company has been distributing dividends. I’d say shares that have a decade-long record are more reliable than those that only just started more recently.
To measure affordability, I’d look at how much a company is earning relative to what it pays out to shareholders. In particular, I can measure this by looking at its dividend cover.
A cover figure greater than one suggests its earnings will cover its cash payout. But to stay on the safe side, I’d ideally look for a figure above 1.5.
Which FTSE 250 shares?
Shares that I think meet my criteria right now include Liontrust Asset Management, Vistry Group, Moneysupermarket.com, Bellway and Vesuvius.
On average, this selection offers a 7% yield, dividend cover of two times and has a 16-year history of back-to-back payments. I’d also expect their earnings to grow over time. That could result in some dividend growth too.
When investing £150 a month for a second income, I’d buy £30 of each of these five shares. Over a year that should result in £126 in dividend income. It might not sound like much now, but over time this could add up considerably.
Taking the long view
Investing is a long-term activity, and as such I’d look at what could happen over many years. For instance, let’s see what might happen if I continue this regular monthly investment over 30 years.
Instead of spending my dividends every year, I’d choose to reinvest them to buy more shares. In turn, these new shares would distribute new dividends. This cycle of dividend reinvestment can have an enormous impact over many years.
I calculate that my reinvesting my dividends, I could build a pot worth over £170,000. That’s enough to produce a second income of almost £12,000 a year.
I have to accept, however, that my investments might not grow and I could lose money. But I’d hope that diversification would reduce my risk.
Even so, much can change over several decades, so I’d need to monitor my share selection to ensure it still meets my criteria. And if it doesn’t, then I can always replace some of my picks with other FTSE 250 stocks that are performing better.