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My passive income list right now would have these 2 ideas on it

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Coming up with ways to earn money without working doesn’t have to be hard. A passive income list can contain simple, practical ideas that are immediately actionable.

A key part of my approach to passive income is putting away spare money in a Stocks and Shares ISA, then investing it in income generating shares. Sometimes shares which generate income can cut or cancel their dividends. That would impact my passive income. That’s why I always try to have more than one stock idea on my passive income list.

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The link between free cash flow and passive income

Looking at earnings can tell a lot about a company’s financial success. However, earnings are an accounting measure. Free cash flow is the surplus money the company generates. That matters when looking at passive income ideas, as paying out juicy dividends for many years requires the right level of free cash flow.

That’s why one of my passive income ideas is Imperial Brands (LSE: IMB). I already own it, but would consider buying more at the current price. The owner of brands such as John Player Special and Lambert & Butler is a cash generation machine. However, its policy of growing dividends by 10% each year meant that dividend coverage from free cash flow slipped. While the difference between earnings and free cash flow may seem academic, that illustrates why it’s worth understanding it when looking for passive income ideas.

The upshot was that Imperial cut its dividend by a third. So, you may wonder, why is it still on my passive income list? The City has apparently cooled on Imperial, which means its share price has fallen compared to recent years. At its current price, the shares yield 9.9%. That means that, for every £100 I put into Imperial, I would expect £99 in passive income each year. If the company raises the dividend, that could increase. Dividends aren’t guaranteed and as tobacco consumption is falling in many markets, free cash flows could be affected down the line.

Basing my passive income list on what I know

I don’t think passive income should require a lot of work. That is why it is called passive, after all.

So that influences me to stick to my circle of competence when assessing passive income ideas. Instead of trying to understand industries or companies I don’t know, I often start by thinking about companies which seem to be well-regarded by my social circle. Then I look into whether they are listed.

Sometimes, well-known, well-run companies are already fully priced by the market. But not always.

Consider Direct Line for example. The insurer is a household name with an iconic brand. Yet these FTSE 250 shares come with a 7% yield. That makes it worth considering for me as a passive income idea.

Insurance can be cyclical, though, which can negatively impact pricing. That could affect the dividend, and indeed last year it cancelled its final dividend amid the pandemic, although it did later pay a special dividend. I also find it discouraging that over the past year, directors have sold but not bought shares with their own money.

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christopherruane owns shares of Imperial Brands. The Motley Fool UK has recommended Imperial Brands. 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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