Earning a second income in the stock market isn’t easy. Investors need to be able to do three fundamental things.
These are working out which sectors are out of fashion with investors, identifying the best stocks within those sectors, and figuring out how to get the cash to buy them.
Where are the bargains?
A good way of working out where the best opportunities are likely to be involves looking at what investors are worried about. And this can vary from one country to another.
In the US, investor concerns have shifted from inflation to economic growth. By contrast, things are relatively benign in the UK.
Economic growth’s been strong compared to other G7 countries and inflation briefly fell to the Bank of England’s 2% target. Barring a weak jobs report from August, things seem positive.
As a result, I’m looking at sectors such as healthcare and consumer staples. Stocks can fall out of favour when things look positive as their growth prospects typically aren’t as strong.
The underlying businesses can be good investments though. And they tend to fare better than others when things inevitably become more difficult.
Individual stocks
I think Tesco‘s (LSE:TSCO) an interesting UK consumer staples company. The UK’s largest supermarket chain is an obvious candidate, but there are some non-obvious positives to it.
The biggest challenge for the business is the rise of discount retailers. These have been expanding their store base and they look set to compete for market share over the long term (Aldi has just announced plans to open 23 more stores across the UK by the end of the year as sales and profit soar).
There’s no way to eliminate this risk entirely. It’s worth noting though, that Tesco managed to maintain its market share at around 27% relatively well over the last 10 years.
The company will have to work to maintain this position. But the firm’s done a good job of matching competitor prices, making it harder for Lidl and Aldi to differentiate themselves.
Tesco dividend yield 2014-24
Created at TradingView
Tesco shares also have an unusually high dividend yield. Other things being equal, that makes it a good time to be considering the stock from a passive income perspective.
Finding the cash to invest
With a stock to buy in mind, the final part is finding the cash to invest. It’s easy to overlook this step and it isn’t always easy, but it’s fundamental to earning a good return over time.
If I invested £100 a month and achieved a 5% annual return, I’d have an annual second income of £4,040 after 30 years. That’s not a bad result, but investing more could lead to better results.
Investing £150 a month at the same rate of return, would get me to £4,040 a year five years earlier. And I’d be earning £6,060 a year after 30 years.
When it comes to investing, there are no guarantees. But if things go well over the long term, the more I invest regularly, the more I stand to get back as a second income.
That’s why it’s so important to keep investing regularly. It’s what turns all the good work in figuring out which stocks to buy into a durable second income.
The post 3 steps to earning a passive second income from dividend shares appeared first on The Motley Fool UK.
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Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco Plc. 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.
