Passive income from dividends is something that a lot of investors look for. Usually, a portfolio of dividend stocks is the best way to generate this cash. The more diversified the portfolio is, the lower the risk that my income will be severely impacted over time due to one or two bad eggs. Given the fact that I’ll hold multiple stocks, I’ll need to pick from many sectors. Here are my top three areas to consider.
Looking to the stability of utilities
The first sector is utilities. This area includes energy providers and water companies. Within the FTSE 100, there are three utility stocks that offer me a dividend yield in excess of the average (3.4%).
The point that makes this area appealing for passive income is the stability of business operations. Most utility providers have their own distribution networks already established. The infrastructure needed means that it’s hard for new entrants to move into the market without serious investment. As such, the major FTSE 100 utility providers have a fairly safe business model, in my opinion.
Due to this, I think the dividends being paid are sustainable in nature.
Clearly, rising energy prices is one risk to my view. Although the larger companies should be able to withstand this for the moment, the increased costs being passed on to consumers could see many looking to change providers in coming months.
Cash flow positives from financial services
Another area for passive income that I like is financial services. This includes insurance providers and investment managers. There are currently five stocks in this sector that offer a dividend yield above 5%.
The element I like from this sector is the cash flow generation. Due to the nature of operations, a lot of businesses in this area have high levels of free cash flow. As an income investor, this is great for dividend potential. It means that this money can be paid out as income to shareholders as one option.
The downside of stocks in this area is their sensitivity to the broader market. For example, take investment management companies. If we see a stock market crash, investors will likely pull their money out and sit in cash. This will reduce the revenue made for the business from the assets under management. So if I’m concerned about the current state of the market, this might be a red flag for me.
High passive income from miners
Finally, I think that good passive income can be made from metals and mining companies. It’s worth noting that the current top three yielding stocks in the FTSE 100 are from this sector. At the same time, I also think this is a higher-risk area than the previous two mentioned.
The main risk here is the fact that the share prices can be very volatile. The correlation to commodity prices is high, depending on which specific metal is being mined. During the good years, a boost from the commodity price can enable large payouts to shareholders. However, in bad years this can easily reverse.
Therefore, although I can’t deny the high yields of 10% aren’t attractive, I’d be careful about investing too much in this specific sector.
But staying diversified with stocks from all three areas should enable me to make the most of my passive income.
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jonathansmith1 and The Motley Fool UK has no position in any share mentioned. 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.