How I’m using big-payout dividend stocks to target early retirement


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In my life in the City, I’ve sometimes heard traders say they don’t have time for dividend stocks: they’re only interested in speculative punts, “double or quit” penny stocks. Some of them managed to make it big, but most of them lost their clothes.

There is no need to take big risks in the stock market. An investor can make some serious money by investing in some really good stocks whose value keeps increasing over time and pays big dividends without fail.

Indeed, this is the Warren Buffett way. It’s been tried and tested.

Dividend stock that earns 7% is my target

£1,000 cash receiving 7% interest a year will double to £2,000 in 10 years. Sounds great, but even with the interest rate hikes, depositors are lucky to earn 1.5% cash interest in the bank today.

However, there are some high paying FTSE 100 dividend stocks that yield 7% or more that have the potential to offer excellent returns. This is what I’m aiming for.

This is because if these companies also increase their profits from year to year then it is likely that dividends and share prices will increase as well. This is the perfect combination!

My initial £1,000 would then grow at a rate higher than 7% and I would have doubled my money long before the 10 years were up.

Merger

But there’s more. If you reinvest the dividends in additional shares in the same company, which then continue to grow, then you make more money. This is compounding. Again, Warren Buffett swears by this.

I have done it with Common law stockfor example, which I originally bought after the market crashed in 2020 due to the Covid-19 outbreak. Stocks have become a profitable investment.

In addition, some companies make so much money that they distribute “special dividends,” i.e. additional payments. I will often reinvest them in the same company as well.

I’m considering buying more shares in Barratt Development, which has a dividend yield of nearly 7% and £1.1bn in cash on the balance sheet. Some analysts expect this cash to be paid out as special dividends.

The risk with high-dividend-paying homebuilding stocks is that higher interest rates and a cost-of-living crisis ultimately deter potential homebuyers.

However, there is a shortage of new homes and demand is still high in the UK. These stocks are worth watching for opportunities to buy when the stock price drops.

A famous trap

One of the risks of a high dividend strategy is being drawn into what is called a “value trap”. These are stocks that offer high dividends and look attractive, but the company basically stops growing. Dividends never increase and are sometimes cut. The stock price then fell. You lose money.

Vodafone is one such example over the last few years, and luckily it’s the only mistake I’ve made with this strategy. One learns through experience.

Sometimes a good takeover or merger can get investors out of the hole, and I’ll see what happens with Vodafone.