Despite the recent stock market recovery, a number of UK shares offer investors the chance to earn a generous passive income.
At a time when interest rates are low and house prices are high, dividend-paying FTSE 100 and FTSE 250 shares could provide a far more attractive income outlook than cash, bonds or buy-to-let property.
Through purchasing high-quality companies with affordable dividends that can grow in the coming years, it’s possible to start earning passive income today.
Investing money in high-quality companies in the stock market recovery
A stock market recovery is likely to have a positive impact on most stocks. However, buying high-quality businesses could provide the best means to start earning a passive income today. Clearly, defining what is meant by ‘high quality’ is subjective.
However, it’s likely to include traits such as a solid balance sheet, a substantial competitive advantage and the potential to adapt to a changing economic outlook over the coming years. Such businesses may provide more resilient dividends that can grow at a fast pace in the long run.
Furthermore, figures such as a company’s dividend coverage ratio can provide guidance on the resilience of its income prospects. Dividend cover is calculated by dividing net profit by dividends. A figure of more than one means net profit covered dividend payouts with room to spare.
Given the uncertain economic outlook, investors may wish to demand a figure in excess of one to provide a more robust passive income. Even as a stock market recovery takes hold.
Reducing risk to start earning passive income today
It’s tempting to buy the highest-yielding UK shares in a stock market recovery to start earning passive income today. While doing so can have merit where those dividends are affordable, it’s imperative to diversify across a broad range of businesses that operate in a variety of sectors. Otherwise, an investor may end up having a large exposure to a limited selection of companies that operate in very similar industries.
Furthermore, today’s highest-yielding stocks may not necessarily produce strong dividend growth in the long run. For example, their high yields may be indicative of a low share price as a result of weak investor sentiment that’s caused by poor financial performance. Therefore, identifying companies that can grow dividends, either through raising the proportion of profit paid to shareholders or by increasing profitability, could be a shrewd move.
The relative appeal of UK dividend shares
As mentioned, the passive income prospects of other mainstream assets are generally disappointing. Even after the stock market rally, many FTSE 100 and FTSE 250 shares offer a potent mix of reliable dividends and long-term growth potential.
By diversifying across multiple sectors and picking companies with well-covered dividends, it’s possible to enjoy a rising income in 2021 and in the coming years.
