10 shares to deliver a £10,000 annual income in 2020

Our ISA shares portfolio gets an overhaul after a successful 2019. Here are this year's 10 star stocks. 

Over the past five years, we have been building a shares portfolio to generate £10,000 of annual income. It hasn’t been easy, but except during a blip in 2018, investors have been rewarded with a decent mix of capital growth and income.

Hardest of all has been achieving consistency with the income objective. For the first three years, we did it, give or take a few hundred pounds. But high-profile dividend payers have run into problems over the past two years, forcing cuts to payouts. In an income portfolio with very precise expectations and just 10 constituents, any slip-up has highly visible consequences. And so it was in 2019.

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Some stocks over-delivered, some fell a little short of expectations, but it was the big miss by Vodafone (LSE:VOD) that meant this portfolio generated just £9,229 of dividend income, although that is still a yield of 6.4% on the £143,000 invested.

Capital return covers income shortfall

A year ago, I forecast that the worst was over for Vodafone. I was wrong. Increased competition in Europe, problems in South Africa, high spectrum auction costs and restructuring forced the board into a 40% dividend cut to help reduce debt. Having forecast a payout of £1,400 for our portfolio, we received just £781, equating to a yield of 4.9% on our investment.

However, in these circumstances, and especially after we had said capital preservation was key in 2019, you would hope that any capital appreciation across the portfolio would make up the shortfall. It did, in spades. Twelve months after investing £143,400 across 10 stocks, the portfolio is worth £153,924: an inflation-busting gain of 7.3%, and more than enough to fill that income gap.

Half the portfolio did lose money. Imperial Brands (LSE:IMB) was hampered by slowing growth, high debt and doubts about vaping products; Sainsbury’s (LSE:SBRY) was the victim of a failed attempt to merge with Asda; and HSBC (LSE:HSBA) suffered as a result of violence in Hong Kong and significant declines in its emerging markets-led global banking and markets division. All three fell by double digits.

However, demonstrating beautifully the benefits of a well-diversified portfolio, even when restricted to just 10 stocks, was the ability of five strong performers to deliver that 7.3% overall capital return between them. Housebuilder Barratt Developments (LSE:BDEV) rocketed by 65%; insurer Legal & General (LSE:LGEN) gained 34%; utility SSE (LSE:SSE) made us a 33% profit; pharmaceuticals giant and our biggest investment GlaxoSmithKline (LSE:GSK) jumped 17%; and green investor Renewables Infrastructure Group (LSE:TRIG) was up 21%.

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Swap shop: the financials

This year there is rather more chopping and changing than I’d like. Because this is a 12-month portfolio, rather than one that rolls over into the following year, it matters less, but it is preferable to maintain some consistency and only swap constituents if absolutely necessary.

However, given the short-term nature of the portfolio, one must give due consideration to not just a company’s potential for income generation, but also its ability to avoid dramatic losses. That’s the theory, anyway.

With that in mind, I’m replacing half a dozen stocks from the 2019 portfolio with others I believe offer better income potential in 2020 and represent better value for investors. The result is a portfolio that costs £14,000 more to build but offers a higher prospective dividend yield of 7%.

To do that, out goes HSBC. That may seem harsh for a stock that delivered the anticipated 6%-plus dividend yield last year, but the shares were the worst-performing of UK bank stocks and, while its Asian markets are promising, I’m switching to a lender closer to home. Lloyds Banking Group (LSE:LLOY) has hardly shot the lights out, but greater political certainty should benefit its UK customer base. An increase in fiscal spending should drive earnings, while Lloyds has room to improve margins and the potential to trigger a re-rating of its shares.

Surely a dividend yield of 7.3% is enough to make Legal & General safe? Nope. It remains a nice stock to own, but I’m trying to sweat this portfolio, and after a 34% increase in the share price last year, the yield drops to a more modest 5.8%. To maintain diversity, I’m bringing in another insurer that is cheaper and offers a prospective yield of 7.5%. Aviva (LSE:AV.) is not without risk, as some question the new strategy and current level of dividend payment, but I believe it is worth backing in 2020.

I want to keep at least one housebuilder in the portfolio, especially as the general election result could be a positive for domestic-focused stocks. Barratt Developments has been a great performer for us, but a rival has turned our heads. Persimmon (LSE:PSN) underperformed rivals as it tackled criticism of its customer care and build quality, but while the share price has improved, there looks to be more catching up to do now that those issues have been resolved. The yield is also among the best in the sector.

Political clarity is good for utilities too, particularly now that the threat of Jeremy Corbyn’s renationalisation programme is removed. But our 2019 star, SSE Group – which produced a 33% profit for our portfolio and a 9.1% dividend yield – now  yields just 5.5%. It makes way for United Utilities (LSE:UU.) which, while yielding slightly less, reduces risk.

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Last year’s gamble on high-yielder Vodafone didn’t quite pay off, although we still enjoyed a 4.9% dividend yield, despite a high-profile cut to the payout. Recruiter Hays (LSE:HAS) takes its place. It offers a generous and well-covered dividend, and the shares trade at a slight discount to the long-term average. An economically sensitive business such as this should prosper if the government fulfils its pledge to invest heavily in UK plc.

A handful of heavyweights

Like it or not, our income portfolio will always contain either BP (LSE:BP.) or Royal Dutch Shell (LSE:RDSB). We have flitted between the two in the past, but there is virtually nothing to separate them in terms of yield and valuation, so we are sticking with BP.

We have been missing exposure to miners too, so given that we are on the hunt for yield, it is hard to ignore the attraction of Rio Tinto (LSE:RIO). The heavyweight digger boasts a good mix of iron ore and copper projects, and attractive growth prospects, while the well-covered dividend is expected to yield 7.5% in 2020. Renewables Infrastructure Group – now trading at a significant premium to net asset value, following a great 2019 – leaves the portfolio to make way for it.

Sainsbury’s let us down last year in terms of share price performance as the Asda merger hit the buffers, but the yield is solid, and while discounters are still pinching market share from the big four supermarkets, Sainsbury’s is cheapest of all and offers good value.

GlaxoSmithKline rarely lets us down in delivering a healthy mix of share price growth and dividend income. Yet the shares have underperformed European rivals and Glaxo retains a wide fan base in the City. The 80p dividend, paid quarterly, should be safe for 2020.

Finally, Imperial Brands, coveted for its decade-long record of 10% annual dividend growth, has reined in expectations. It yielded 8.4% for us in 2019, but the payout may grow by less than inflation in 2020, as dividend policy will now be closely tied to the underlying performance of the business. However, given that its shares have fallen sharply over the past year and with prospects undervalued, the current double-digit yield is worth the risk.

Revised and revitalised: new portfolio for 2020

Source: SharePad, analyst estimates, as at 7 January 2020

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