The coming weeks will likely see a rush of investors putting money into UK dividend shares in an attempt to beat the year-end ISA deadline. If I had £20,000 to invest in income shares in my ISA right now, here is how I would do it.
Think a decade ahead
As an income investor, I would be thinking not just about the potential for dividends now, but also in the future. To pay out dividends consistently over time, a company needs a business model that is likely to generate surplus cash both now and in the future.
One way to do that is to imagine the world in 2032. What sorts of business that already pay dividends today might continue to be doing well then and generating substantial free cash flow? I would say there is a high chance that demand will remain high for utilities like National Grid and Pennon. I also expect people will still be buying premium brands from consumer goods giants such as Unilever and Diageo.
What about emerging industries that could be doing well in a decade? I see ongoing growth potential in online retail. I also expect technology firms delivering technical infrastructure as well as software services to do well. Cybersecurity could be another big growth area. A lot of companies in these areas do not currently pay dividends – but could that change in the coming decade? Maybe it will. From an income perspective, though, I would rather invest in dividend shares that are paying out now and hopefully will keep paying, rather than businesses that do not already pay dividends.
Diversifying my ISA picks
To reduce my risk, I would diversify across different companies and business areas. With £20,000, I could invest £2,000 in each of 10 different companies. My plan would be to limit my choice to two from any one business area.
So, for example, I would buy both Imperial Brands and British American Tobacco. The duo of British tobacco giants face the risk of declining cigarette demand hurting revenues, but their new lines of products like modern oral are growing fast. Meanwhile, cigarettes continue to fuel huge cash flows.
I would also plump for insurers Direct Line and Legal & General. With well-established brands and resilient demand, I see them both as potentially rewarding UK dividend shares for my ISA. Changing rules on insurance pricing transparency may hurt profitability. But the reverse might also happen – a simpler marketplace could lead to lower costs for providers, boosting profitability.
UK dividend shares to buy now
Consumer goods giants Unilever and Reckitt face a risk to profits from high inflation. But I think their premium brand portfolios give them pricing power that could help combat this. Unilever’s current yield of 4.5% should produce £90 of income annually for my £2,000.
Among the utilities, I would buy National Grid and United Utilities. They benefit from robust demand I expect to last for decades. Shifting patterns of electricity use could mean capital expenditure hurts profits, though.
Finally I would buy 10%+ yielding housebuilder Persimmon and 9.6% yielder Income & Growth Venture Capital Trust. High yield often signals perceived risk –- a declining British economy could hurt profits both for Persimmon and the companies in which Income & Growth invests. But I feel the risk is priced in to these final juicy yields for my ISA.
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Christopher Ruane owns shares in British American Tobacco, Imperial Brands and Unilever. The Motley Fool UK has recommended British American Tobacco, Diageo, Imperial Brands, Pennon Group, Reckitt plc, and Unilever. 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.
