Generating passive income from FTSE 250 stocks appeals. However, the risk has got to be worth the reward. In other words, I’d need to be confident of receiving a better yield than I’d get from just holding a simple index tracker and doing nothing else (currently around 1.8%).
Fortunately, I think this is easily beatable. In fact, I’ve found a couple of stocks that should generate a far higher amount of cash for me.
6% dividend yield
The first high-yielding dividend stock to discuss is fund manager Jupiter Asset Management (LSE: JUP). Right now, shares in JUP can be picked up for 9 times earnings. That looks a great deal to me.
While certainly not the highest in its industry, operating margins of 27% are far better than many FTSE 250 constituents achieve. Recent years aside (due to the pandemic), the company also generates strong returns on capital — just the sort of thing I look for when selecting stocks.
But, of course, it’s the dividends we’re interested in here. On this measure, JUP knocks it out of the park.
Analysts currently have Jupiter returning 17.1p per share for FY21. Using the current share price, this becomes a yield of 6.5%. For perspective, that’s over 10 times what I’d get from the best instant access Cash ISA.
It gets better. Based on earnings estimates, this cash return should also be covered 1.7 times by profit. As such, I doubt a dividend cut is on the horizon anytime soon.
Obviously, never say never. As last year showed, firms can be quick to amend their policies on distributions in the event of severe headwinds. Stocks in the financial sector that Jupiter belongs are particularly vulnerable in this regard.
Another big yielder from the FTSE 250
A second FTSE 250 stock offering what appears to be a very enticing income stream is insurer Direct Line (LSE: DLG). It’s down to yield 24.3p per share this year. Using the current share price (305p, as I type), that gives a stonking dividend yield of 8%!
In addition to this super payout, the company trades on what looks to be a cheap valuation (12 times earnings). That seems a whole lot more palatable compared to some stocks.
However, there are also a few things I’d need to be aware of before pulling the trigger. Unlike Jupiter, returns on capital are very low. The share price performance certainly isn’t worth shouting about either.
DLG shares are actually down 17% since 2016. Contrast this with the FTSE 250’s 34% rise and it seems clear to me that, based purely on capital gains, this stock won’t make me rich anytime soon. On top of this, dividend cover looks stretched (one times profits). Hopefully, this will prove temporary.
Still, I’d be happier to buy DLG shares over hoarding cash. Keeping some money on the sidelines for emergencies and in preparation for the next correction/crash is never a bad thing. However, having an abundance for too long would be a spectacularly bad financial decision on my part.
Equities, while certainly higher risk, are nearly always a better option if I can ride out the inevitable waves of volatility.
All things considered, I’d be more comfortable buying more JUP than DLG for my portfolio. Then again, an 8% yield isn’t to be sniffed at, so long as I also had exposure to other sectors.
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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Jupiter Fund Management. 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.