10 shares to give you a £10,000 annual income in 2023

Despite difficult market conditions, our head of equity strategy has proved again that you can generate an attractive annual yield from company dividends far in excess of cash.

There were plenty of themes at play for investors last year, among them the decline of big tech and growth, the energy boom, and outperformance of UK large-cap companies. But one that stands out for me is income.

A bull market that had run since the end of the financial crisis in 2009 - admittedly with major blips in 2018 as the US raised interest rates, and at the beginning of the Covid pandemic in 2020 – ended for growth stocks in November 2021. A new programme of rate hikes both here and in the US to curb inflation, made businesses dependent on borrowing money to fund growth less attractive.

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At the same time, other forms of typically safer investments such as bonds and cash began to offer returns not seen for many years. In the UK, during the chaotic reign of Prime Minister Liz Truss, her chancellor’s mini-budget of tax cuts in September triggered a boom in yields on government bonds, or gilts. The 10-year UK Gilt rose from 2.8% at the start of September to 4.5% at the end of the month. Rates on easy access savings accounts are currently just under 3%, or about 4.4% for the best fixed-term deals.

The likelihood of future interest rate rises both here and overseas is expected to underpin current high yields on bonds and cash, at least until inflation is considered under control and rates decline again.

However, these returns fail to beat the 7.1% yield achieved by my annual income portfolio in 2022. The objective is to generate at least £10,000 of annual dividend income over the 12 months, using a diversified basket of 10 shares.

This time, all but two of the 10 constituents were there or thereabouts in terms of the level of income I’d expected at the start of the year. The two outliers were near enough, and payment of a special dividend was a welcome boost, and meant the portfolio generated dividend income of £10,861.

The £153,000 I used to build this portfolio was one of the lowest in the eight years I’ve been doing it. Like the year before, mining giant Rio Tinto (LSE:RIO) starred, this time with a yield of 11.1%, including another special dividend. 

There was no positive capital return in 2022, however. The portfolio fell in value by 2.7%, the result of losses in the region of 40% at both insurer Direct Line (LSE:DLG) and housebuilder Persimmon (LSE:PSN). But diversification proved its worth again, with both Rio Tinto and BP (LSE:BP.) up over 20% and other constituents cancelling each other out.

Subtract the £4,200 decline from the income received and you still get a total return of 4.4% for the year to 24 January 2023.

This portfolio starts each year with a clean slate, so there will be some changes in the line-up for 2023. Here are the stocks that stay, those that don’t and a bunch of new entries.

Star performers in the 2022 income portfolio were…

The obvious winner this past year has been Rio Tinto, a true all-rounder. Income of £1,660 for a dividend yield of 11.1%, plus capital return of 21%, exceeded expectations. Business became more challenging as the year progressed, blamed on weaker iron ore prices as China’s Covid lockdown cooled demand, and rising costs. But even a reduced half-year payout in July of $4.3 billion was its second highest ever interim dividend.

US-focused gas and oil production business Diversified Energy Co (LSE:DEC) delivered the near-10% yield it was bought to do. The £1,200 of income plus 12% share price gain demonstrated why it was kept in the portfolio for a second year.

This is an income portfolio, but it’s the 24% price rise that makes BP a standout this time, with the war in Ukraine continuing to underpin global oil prices. A 4.9% dividend yield was both predictable and welcome.

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I’ve got to mention Persimmon for the 9.8% yield, but the rapid deterioration in appetite for housebuilders through the year can’t be avoided. Shares in the country's largest housebuilder had already fallen sharply when I picked the stock due to concerns about rising taxes, higher interest rates and the end of Help to Buy. I didn’t think they’d bounce back, but I didn’t expect them to fall as far as they have either. A 41% share price slump surprised me, but allocating only £8,000 to the stock proved sensible. This cyclical business will recover in time.

Elsewhere, utility SSE (LSE:SSE) contributed £1,100 of income for a yield of 5.6%, then chipped in with a 9% capital gain. M&G (LSE:MNG) and British American Tobacco (LSE:BATS) suffered minor losses but the former yielded 8.5% and BAT 6.9%. Legal & General (LSE:LGEN) had a tough year, made worse by the market turmoil in September. However, a 6.5% dividend yield offset a chunk of the 10% capital loss. Sainsbury (J) (LSE:SBRY)’s shares yielded 4.7% but fell 17% in value as inflation, competition, higher interest rates and concerns about the economy forced shareholders into a rethink.

Who stays and who goes?

A lot of thought is given to which stocks make the annual income portfolio, but some decisions are easier than others. Easiest decision this year was to eject Direct Line. Higher second-hand car prices and cold weather forced up claims costs for the motor and home businesses respectively, which means the company can no longer afford a final dividend for 2022. It’s not clear what, if anything, will be paid in 2023.

Possibly the biggest shock this year is the omission of both BP and Shell (LSE:SHEL). It’s the first time neither of the FTSE 100’s oil majors has made this portfolio. That’s because the surge in share price, particularly following Russia’s invasion of Ukraine almost a year ago, has made their forecast dividend yields of under 4% much less attractive.

However, reliable cash generator Diversified Energy Company warrants inclusion yet again, which means the energy sector does have a presence and provides us with valuable diversification. Reassuringly, it’s just confirmed that results for 2022, to be published on 21 March, are in line with market expectations. Strong free cash flow should mean regular and very generous dividends through 2023.

Second shock is the decision to leave out Rio Tinto and not replace it with rival dividend star Glencore (LSE:GLEN). Rio’s special dividends look less likely to be repeated this year, and the demand outlook is less certain.

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A handful of FTSE 100 income shares I picked for last year’s portfolio have done enough to make the 2023 edition.

Three of the portfolio’s big dividend payers - Legal & General, British American Tobacco and M&G – make the cut. L&G’s strong balance sheet and “significant buffers to absorb a market downturn” give it confidence in its ability to keep paying attractive dividends. BAT has been held back by certain headwinds, among them investor rotation back into cyclical stocks. However, the yield is too tempting, and a lot of caution is already baked into the price.

M&G has been a consistent and substantial contributor to this income portfolio, so deserves a third year. It is highly geared to rising interest rates and most City analysts believe the big dividend will survive.

Elsewhere, SSE has scaled back its payouts to fund investment and growth plans, but the portfolio will still benefit from a final dividend on the more generous policy before it is rebased for the year to 31 March 2024. It’s not one of the mega yields, but it is reliable. Sainsbury’s is another dependable payer, although the yield is more modest.

Four more for 2023

Deteriorating economic conditions and reduced government help for homebuyers make dividends in the housebuilding sector appear vulnerable. However, I want exposure to this cyclical industry that still offers eye-catching yields. That’s why I’m switching out of Persimmon and into Taylor Wimpey (LSE:TW.).

Taylor Wimpey shares have fallen sharply, in line with rivals, but the generous payout should be safer than peers. That’s because its dividend policy is not based on earnings cover targets. Instead, it promises to return 7.5% of net assets to shareholders annually, or at least £250 million a year.

Too much uncertainty around Vodafone (LSE:VOD) and its dividend policy means I won’t consider it this year. We need security at times like this, and that’s what a defensive stock like GSK (LSE:GSK) delivers. It also gives us diversification into a sector we’ve not had in this portfolio since 2020 following the company’s decision to ‘rebase’ its dividend.

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Given economic circumstances now favour the banks, I’m recalling another old friend to the portfolio this year - Lloyds Banking Group (LSE:LLOY). It’s the first time I’ve included a bank in the portfolio since a disastrous year for Lloyds in 2020. Conditions are more favourable now, the dividend is attractive, and the lender offers further diversification.

Finally, I’m pinching another of my speculative income tips for 2023 for this portfolio. Sylvania Platinum (LSE:SLP) runs platinum group metal, or PGM, processing plants across South Africa's lucrative Bushveld complex. It has exciting mining rights too. The business enjoys high operating margins and return on capital, is reasonably priced and can afford a generous dividend. It’s also just increased production guidance for 2023 after reporting a strong first half trading.

Source: SharePad, analyst estimates. All figures as at 31 January 2023.