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When dividend yields start to climb beyond 6%, it can be an early warning sign to income investors that something’s wrong. That’s been because the higher the yield, the harder it is to sustain, likely eventually resulting in a payout cut. And since stock prices have a habit of crashing on such announcements, it can leave shareholders in a weak position.
However, even with UK shares reaching a new record high in 2025, there remain plenty of promising income opportunities. And if selected carefully, a sustainable long-term 7% yield could be unlocked.
Focus on cash flow
Most income investors start by looking at the highest-yielding opportunities available. Right now, that’s Legal & General from the FTSE 100 at an 8.6% payout and NextEnergy Solar Fund from the FTSE 250, at 11.5%. However, as previously stated, investing in these companies would be pointless if they can’t maintain this level of payout.
Instead, investors should look towards a business’s free cash flow-generating capabilities. Why? Because at the end of the day, free cash flow is what allows a company to fund and increase shareholder payouts. And so it should be no surprise that the best-performing investments on the London Stock Exchange have almost exclusively been highly cash-generative enterprises delivering steady and consistent growth.
Building a 7%-yielding portfolio
Anyone can unlock a 7% yield right now by just throwing money into a stock offering with this payout. But as previously explained, this is likely a losing strategy. That’s why for my income portfolios, I’m not looking at the stocks offering a 7% yield today, but rather the ones capable of growing their dividend yield over time, thanks to impressive free cash flow generation.
A recent example of this success story would be Games Workshop (LSE:GAW). At the start of 2020, the Warhammer miniature manufacturer offered investors a seemingly insignificant 2.3% yield.
However, the business itself had been thriving under the new leadership of Kevin Rountree, with impressive sales, earnings, and most importantly, free cash flow growth. By continuing to execute its winning strategy, those trends not only continued but accelerated. And with more money flowing to the bottom line, dividends have drastically increased in the last five years.
The result? A £10,000 investment in January 2020 is now not only worth closer to £22,600, but also generates an impressive 7.8% dividend yield on an original cost basis.
Still worth considering today?
Opening a new position in Games Workshop today will once again only generate a 2.7% yield. But if the business continues to outperform, that could climb to a more meaningful level in just a few short years. So is it a good idea?
It may be. But there are some important risks to consider that were a major concern five years ago. The exceptional one-time licensing revenue is creating some tough comparables, the group is suffering from rising cost inflation regarding production, and the impact of tariffs could all hamper its free cash flow growth.
So far, management seems to be navigating these threats. And personally, I remain optimistic for the long term. But if these headwinds grow stronger, the journey towards a 7% yield could take far longer than expected.
