I believe owning dividend stocks is one of the best ways to generate a passive income. With that in mind, here are two income stocks I already own and will be buying more of in the future.
Top dividend stocks
The first company is the insurance group Direct Line (LSE: DLG). There are a couple of reasons why I like this business.
For a start, it is one of the largest car insurance companies in the UK. As car insurance is a legal requirement, and is likely to remain so for the foreseeable future, this gives the business a vast captive market.
The group also sells home insurance and other add-on products, giving consumers a one-stop shop. I think this only increases the company’s appeal to customers.
The company’s size also provides an advantage and helps its appeal as one of the market’s best dividend stocks. Its size means it has significant economies of scale. As such, it can keep costs low, which helps profit margins.
Despite its advantages, Direct Line also faces risks and challenges. For example, a series of significant natural disasters could cause an elevated level of losses. In this scenario, the company might have to reduce its dividend to cover customer losses.
On the other hand, if costs increase, the company may also face tighter profit margins.
Even after taking these challenges into account, I’m attracted to the corporation and its 7.4% dividend yield. That’s why I would buy more of the stock for my portfolio.
As well as Direct Line, I would also buy more of drinks giant Diageo (LSE: DGE) for my portfolio of dividend stocks.
While these two companies operate in completely different sectors and produce entirely different products, I think they exhibit similar qualities.
Like Direct Line, Diageo owns a portfolio of well-known household brands. It’s also one of the largest alcoholic beverage producers globally, which means it has substantial economies of scale.
I think these qualities can support the company’s dividend. Shares in the group offer a dividend yield of 2.1%, and the payout is covered 1.6 times by earnings per share.
This ratio implies the company is paying out around 75% of profits to investors as dividends. I think this level is quite attractive because it leaves headroom to fund growth initiatives. Such a modest payout ratio also gives the group financial flexibility.
I think these are all desirable qualities, and that’s why I would buy more of the company for my portfolio of dividend stocks.
A critical risk the company is facing right now is rising commodity prices. As a result, Diageo’s profit margins could come under pressure if it cannot pass higher costs on to customers. That may mean the business has to reduce its dividend payout if profits fall substantially.
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Rupert Hargreaves owns shares in Direct Line and Diageo. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2021