Over 50 now, I am focusing on maximising the passive income I can make from investing in shares. This requires little effort on my part – hence the word ‘passive’ – aside from picking the right stocks and monitoring their progress occasionally.
I should be able to keep reducing my working commitments and live off the dividends if I do this right.
This additional stream of income has provided many benefits even before now, which is why I recommend starting young. It helped me get on the property ladder early, take more exotic holidays, and better provide for my children.
A longer period of investment also allows shares more chance to recover from any short-term market shocks.
It additionally enables greater returns to be made over time through ‘dividend compounding’. This is where dividends paid by a company are used to buy more of its shares.
Key qualities in passive income shares
The first thing I want is a high yield, naturally enough.
Imperial Brands (LSE: IMB) – one of my high-yield stocks – last year paid a dividend of 146.82p a share.
On the present share price of £21.85, this yields 6.7%. Analysts forecast this will rise to 7.4% in 2025 and 7.9% in 2026.
The second element I look for is share undervaluation. This lessens the chance of an extended price fall erasing my dividend gains, in my experience.
A discounted cash flow analysis shows the stock to be 65% undervalued at £21.85. So a fair value for it would be £62.43, although it could go lower or higher, of course.
The final factor I want is good business growth prospects. This tends to support increases in share price and dividends over time.
Analysts forecast that Imperial Brands’ earnings per share will grow 5.9% a year to end-2026. Return on equity is forecast to be 54.4% by that time.
There are risks to this outlook, as there are for all businesses. The main one in my view is any significant delay in the firm’s transition from tobacco products to nicotine replacements. Regulations against smoking are increasing and it needs to respond quickly to this.
How much passive income could be made?
Taking the £11,000 average in UK savings and investing it at 6.7% would make £737 in dividends in year one. Over 10 years this would rise to £7,370, and over 30 years to £22,110.
These results are based on two things. First, the yield averages the same each year, despite share prices and dividend payments fluctuating as they do. Second, the dividend payments are removed from the share account for whatever reason.
If they were left in the account and used to buy more Imperial Brands’ shares, much more could be made.
After 10 years of doing this, the additional return would be £10,457, not £7,370. Over 30 years it would be £70,639 rather than £22,110!
This, plus the initial £11,000 investment, would pay £5,470 in passive income each year, or £456 every month.
Inflation would reduce the buying power of the money over the period, of course. However, it underlines how significant passive income can be generated from much smaller investments over time.
This post was originally published on Motley Fool
