Passive income is money made from minimal effort. I aim to maximise this to further reduce my working commitments, aged over 50 as I am.
The best way I have found to do so is by investing in shares that pay high dividends. And one of my top stocks in this regard remains the FTSE 100 investment management firm M&G (LSE: MNG).
How much passive income can be made?
In 2023, it paid a 19.7p dividend. On the current share price of £1.95, this yields 10.1%.
By comparison, the average yield of the FTSE 100 is just 3.5% and of the FTSE 250 only 3.3%.
So, £6,000 (just over half the average UK savings amount) would generate £606 in dividends in the first year. On the same average yield, these payouts would rise to £6,060 over 10 years – more than doubling the initial investment. And over 30 years on the same average yield, the dividends paid would be £18,180.
The miracle of dividend compounding
This is a lot better than could be made from a standard UK savings account. But it could be even higher if the dividends were used to buy more M&G shares.
This is known as ‘dividend compounding’ and is a similar idea to letting interest accumulate in a bank account.
Doing this on the same average 10.1% yield would generate £10,404 in dividend payments after 10 years, not £6,060. After 30 years on the same basis, the dividend payments would increase to £116,619 rather than £18,180.
Adding the initial £6,000 investment would make the M&G investment worth £122,619.
Based on the same 10.1% average yield, this would generate £12,385 in passive income every year or £1,032 each month.
Are these high dividends sustainable?
Ultimately, a firm’s earnings drives its dividends (and share price). A risk here for M&G is the high degree of competition in the sector that might squeeze its profit margins. Another is a resurgence in the cost of living that might cause customers to close their accounts.
However, consensus analysts’ estimates are that its earnings will grow a stunning 28.5% a year to the end of 2026.
Consequently, the forecasts are also for a rise in its dividends over the period. Specifically, projections are for dividends of 20.1p this year, 20.6p next year, and 21.3p in 2026.
On the current £1.95 share price, this gives respective yields of 10.3%, 10.6%, and 10.9%.
Is the stock undervalued as well?
If I ever wanted to sell the stock, I would not want to do so at a loss, of course. To reduce the chances of this happening, I only ever buy shares that look undervalued compared to their competitors.
A key measure I use to ascertain this is the price-to-book ratio. M&G currently trades at just 1.2 on this measure against an average 3.5 for comparable firms. So it is cheap on this basis.
To ascertain how cheap in cash terms, I ran a discounted cash flow analysis. This shows the stock is 52% undervalued at its present price.
Therefore, a fair value for the shares is £4.06. although they may go lower or higher, given market unpredictability.
Given its very high yield, extreme undervaluation, and exceptional earning growth prospects, I will be buying more of the stock very soon.
This post was originally published on Motley Fool
