Stock market recovery: is it too late to make a passive income from cheap shares?

Can investors still make a worthwhile passive income from cheap shares despite the recent stock market recovery’s impact on company valuations?

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The recent stock market recovery could make it more difficult to make a large passive income from cheap shares. After all, higher stock prices mean lower yields. Especially when a limited number of companies have increased their dividend payouts in today’s challenging economic circumstances.

However, some sectors have underperformed the wider index. Meanwhile, others continue to trade at low levels compared to their historic averages. As such, it’s still possible to identify high-quality cheap shares that can produce a generous, and growing, passive income.

Buying cheap shares after the stock market recovery

Despite the recent stock market recovery, the FTSE 100 continues to trade below its all-time high. In fact, it’s around 15% down on its record high. This suggests a number of companies could still be classed as cheap UK shares. Certainly since they may have failed to fully bounce back from the 2020 stock market crash.

Furthermore, some sectors have significantly underperformed the wider stock market. Examples include, but are not limited to, banking, energy, travel & leisure. You can also add some retailers who’ve negatively impacted by store closures during lockdown. Their share prices may fully reflect the uncertainty faced over the short run. As such, they could offer good value for money. As well as a generous passive income over the long run.

Making a passive income in an uncertain economic period

Cheap shares continue to offer high yields after the stock market recovery in some cases. So making a passive income is more than just focusing on today’s shareholder payouts. Consideration must be made to the affordability of dividends over the long run. That’s because some companies may struggle to deliver rising profitability for a prolonged period of time following the current economic crisis.

As such, checking the quality of cheap shares could be a sound move. For example, assessing their balance sheet strength, the adaptability of their business models and their competitive advantages could be a sound means of analysing the reliability of their dividend payouts. Cheap shares that lack such characteristics may be worth avoiding. Even if they offer high yields and large discounts compared to their sector peers.

Building a dividend portfolio

As well as analysing cheap shares to check the affordability of their passive incomes, building a diverse portfolio of companies could be a shrewd move at the present time. After all, the recent stock market recovery is not guaranteed to continue. It could turn into a stock market crash at any time. The stock market could experience further ups-and-downs that negatively impact on an investor’s portfolio.

Although diversification doesn’t reduce risk to zero, it can lower an investor’s dependency on a small number of shares for their passive income. This may result in a more reliable and resilient income stream over the long run.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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.

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