If I had a lump sum of £5,000 to invest today, I would deploy this money in the stock market to generate a passive income. Indeed, I think it could be possible to achieve a yield of 10.7% on this money, providing an annual passive income of £535.
Shares to buy for passive income
A handful of stocks on the market today offer dividend yields of 8%, or more. Two of my favourite are British American Tobacco and Persimmon. The tobacco company and homebuilder offer dividend yields of 8.3% and 8.7% respectively.
The reason why I like these two companies over other opportunities on the market is the fact that they are predictable. Persimmon laid out its plans in 2013 to return significant amounts of cash to investors every year. Management is sticking to this plan, making it easier for investors to see how much cash they will receive in the year ahead.
Meanwhile, British American is incredibly cash generative. Its dividend payout is well covered by earnings per share, and management is pursuing a progressive dividend policy. This means the payout increases every year, in line with earnings growth.
Income from commodities
These are not the only two companies with dividend yields of 8% or more I would buy for my passive income portfolio. I would also acquire mining giant Rio Tinto. This stock will yield 17% in 2021, according to analysts, and 11% in 2022.
Unfortunately, these payouts are not as predictable as those outlined above. As an iron ore producer, Rio’s profits are linked to the price of this crucial commodity. Therefore, if the iron ore price collapses, Rio may have to scale back its dividend commitments.
That is not to say British American and Persimmon’s dividends are gold-plated. Both companies could be forced to cut their distributions if sales and profits suddenly lurch lower. Shareholder returns are usually the first place management looks to cut cash outflows when a business is experiencing stress.
Another commodity company I would buy for my portfolio with a dividend yield in the double digits is the steel group Evraz. According to analysts, the stock’s yield could hit 17% this year and 15% in 2022. Once again, this dividend could be at risk if steel prices suddenly decline, or if there is an economic downturn.
Dividend potential
By acquiring an equally weighted portfolio of all of the companies outlined above, It could offer a dividend yield of 10.7%. This could form the foundations of my passive income portfolio.
As I noted above, an investment of just £5,000 could provide a passive income of £535, based on that average yield of 10.7%. And if I increased my investment pot to £10k, I could generate an annual passive income of £1,070.
Still, investing in these income stocks may not be for everyone. A dividend yield in the double-digits could be a sign that the market does not believe the payout is sustainable. This suggests any one of the businesses outlined above could cut the distributions at a moment’s notice.
Although I am comfortable with the level of risk involved in this strategy, other investors may not be.
Rupert Hargreaves owns shares of British American Tobacco. The Motley Fool UK has recommended British American Tobacco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
This post was originally published on Motley Fool
