Filling a Stocks and Shares ISA with high-yield dividend shares is a popular strategy for investors seeking to build long-term passive income streams.
The approach can be highly rewarding, but it carries potential pitfalls that investors should carefully consider before committing capital to the strategy.
A scan of the highest-yielding shares in the FTSE 100 reveals several recurring themes, with the top 10 dominated by financial services companies, property businesses, and tobacco shares.
A similar pattern emerges in the FTSE 250, though with a different sectoral emphasis, where renewable energy companies feature prominently among the highest yielders.
The concentration of high-yield shares in specific sectors is not always a warning sign, but it does highlight the importance of understanding why certain stocks offer elevated income.
In the case of renewable energy shares, elevated yields can reflect investor concern about dividend sustainability in light of ongoing uncertainty around future energy policy.
Diversification across multiple sectors remains essential, as too heavy a concentration in any single area leaves an ISA exposed if that sector’s fortunes deteriorate sharply.
Knowing exactly what you are buying is equally important, and for some high-yield shares that assessment is relatively straightforward compared with more complex financial services firms.
British American Tobacco (LSE: BATS), the FTSE 100 cigarette maker, is one example where business fundamentals are easier to analyse, though risks around declining cigarette volumes remain real and present.
Unlike rival Imperial Brands, which cut its dividend sharply in 2020, British American Tobacco has maintained a track record of annual dividend growth stretching back decades, with a current yield of 5.8%.
The company aims to keep growing its dividend per share annually, though neither management aspiration nor past performance are guarantees of what to expect in future from a share.
Cigarette sales volumes at British American Tobacco are already in steady decline, creating a potential threat to future revenue and profit levels that could weigh on dividend sustainability.
Its portfolio of premium brands like Dunhill provides some protection, giving the company pricing power to help offset the profit impact of lower sales volumes over time.
British American Tobacco has also spent years building out its non-cigarette business, broadening its revenue base beyond traditional tobacco as the market continues to shrink.
Assessing dividend sustainability is ultimately one of the most critical steps any investor should take before selecting a high-yield share for inclusion in their ISA portfolio.