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There are many ways to earn a second income – and not all of them involve getting a second job. For example, one common way people earn some extra money without working for it is buying shares that pay them dividends.
However, not all shares pay dividends – even if they have done in the past.
Shares that don’t pay dividends
Take Tesla for example. The company has been having a tough time in the past few months. But it still made billions of dollars of profits last year.
So if someone put £5k into Tesla stock today, how much second income might they earn?
The answer, for now at least, is likely zero. Maybe if the Tesla share price moves up they could sell the shares at a profit and make some money – though it could also go down. But in terms of dividends, Tesla has not yet paid one.
Why, given that it is highly profitable? A company can choose how to use its spare money – and in Tesla’s case (as with many growth companies) it prefers to use spare money to fund growing the business, for example through new ventures, than paying a dividend.
That may change in future, but I do not expect Tesla to pay a dividend any time soon.
High-yield dividends can also signal high risk
Ought the investor seeking a second income therefore to look at shares that already pay a dividend? If it is a large one relative to the share price, that could be lucrative (this is what is known as a high-yield share).
Take Diversified Energy for example. Its 8.4% yield would equate to an annual £420 second income for a £5k investment (though in practice, an investor always ought to keep their portfolio diversified).
With its large estate of gas wells, the company might keep pumping out cash as well as energy. But it might not. It has cut the payout per share before. I see a risk that the firm’s debt load combined with volatile energy prices could mean another dividend cut in future.
Looking for the source
Instead of focusing on today’s yield, when I weigh adding a share to my portfolio, I do what I just described with Diversified. I consider what I think the source of its future dividends is likely to be and weigh the risks alongside the opportunity.
For example, Guinness brewer Diageo (LSE: DGE) offers a far lower yield than Diversified Energy, of 3.9%. That is still above the FTSE 100 average though. Five grand earning a 3.9% yield ought to generate an annual second income of around £195.
Diageo has raised its dividend annually for decades. But as I said above, that does not guarantee what happens in future. Demand has been weakening in Latin America and I see a risk that lower alcohol consumption among younger generations could mean revenues and profits falling in future.
Still, Diageo has a large target market of customers. Its portfolio of premium brands, unique production facilities an global distribution network are all competitive advantages. It is hugely profitable and, hopefully, if it remains that way, will keep paying out dividends.
So while I own neither Tesla nor Diversified Energy shares, I do have a stake in Diageo, boosting my second income.
