Have you ever wondered whether stock dividends can actually generate a significant second income?

They certainly can, but whether this happens depends on several factors: how much one invests, for how long, and what the dividend yield is. To illustrate this, what kind of second income could someone generate with a sum of £20,000?

Taking the long term into account

As I mentioned, time frames matter. I prefer a long-term approach to investing. This gives companies time to prove themselves and hopefully accumulate dividends.

There are several ways to obtain a second income. One of them would be to invest 20 thousand. pounds and start paying dividends as soon as they are received. At a rate of return of, say, 5%, this should give you a second income of £1,000 a year.

An alternative approach, however, is what’s called compounding: initially reinvesting the dividends. Then, at some point, the dividends can be used as income rather than continuing to accumulate them.

For example, after 10 years, at a compound annual growth rate of 5%, the portfolio should be worth approximately £32,578. At a dividend yield of 5% this should generate a second income of around £1,628 per year.

Or instead continue compounding for another 10 years, the portfolio should then be worth over £53,000. At a dividend yield of 5% this could provide a second income of £2,653 per year.

Getting started

Diversification is a plain but vital risk management strategy: 20,000. pounds is enough to spread over many shares.

Trading fees and commissions can also cost you money, so an experienced investor should consider their options when choosing a shares trading account or a Stocks and Shares ISA.

A gigantic dividend payer

As an example, I gave a target profitability of 5%. Actually, a little more than now FTSE100 profitability 2.9%. But I think it’s still possible if we stick to high-quality blue-chip companies.

I believe investors should consider one income share British-American tobacco (LSE: BATS). The company has a global reach, a robust distribution network and a stable premium brand such as Happy Stroke that give it pricing power.

Raising prices can aid mitigate the decline in sales volume, but only if volume falls far enough.

British American offers a dividend yield of 5.6%. The future rate of return is actually higher because British Americans intend to raise dividends per share every year, as they have done for decades.

Dividends are not guaranteed, however, and the risk is a decline in cigarette sales. Moreover, the company lost volume share in its most vital markets last year. As market size decreases, maintaining or increasing share would be better for efficiency.

Meanwhile, the company is also expanding its non-cigarette business while cigarette consumption declines.

From an ethical perspective, not all investors are comfortable with tobacco stocks. Personally, I think the stock has ongoing significant dividend potential.