One of my favourite passive income ideas in investing in dividend shares. But even as somebody already buying such shares, I think there are habits I can develop to help me boost my earnings. Here are five of them.
1. Increase how much I invest for passive income
The simplest way to double or even triple the passive income I generate from dividend shares is simply to double or triple the amount I invest.
That may sound very simplistic – and it is. I think it is easy to overcomplicate the process of generating passive income. Investing more money would not only increase my passive income streams because I would own more shares. It could also cut the costs I paid to buy, hold, or sell shares, as I may benefit from some economies of scale.
This could be hard for me to do if I was already using a lot of my spare money investing. But I notice that a lot of people seem to invest only a small amount each month, with some vague plan of increasing the amount as they get closer to retirement. But doubling my monthly investment 30 years before retirement will have much more impact on my future passive income streams than doing it just a few years before I retire.
2. Look for dividend growth prospects not just yield
A lot of investors zoom in on dividend yield when building a passive income portfolio. I understand why they do that, but I think it is only one of the pieces of information that I need to use in that situation. If I want to increase my passive income streams, I also need to consider the prospects for future dividend growth.
Consider GlaxoSmithKline as an example. Its yield is 4.9%, which I find attractive. But I note that its dividend this year is on track to be 80p. Last year it was 80p. It was 80p in 2019 — and 2018 — and 2017. You get the picture.
By contrast, a company with a slightly lower yield but that will hopefully grow its dividend each year might improve my future passive income streams compared to investing in a business where the payout is flat. GSK’s might even go down, incidentally, as it has warned that after a proposed breakup the total dividend may not match the current 80p per GSK share.
3. Look at free cash flow
Dividends are never guaranteed. Neither is dividend growth. But a company that has excess free cash flows that grow in size each year has the financial flexibility to grow its dividend. By contrast, if a company has shrinking free cash flows, its financial room for manoeuvre will decrease. Once the dividend exceeds the free cash generated, the company will either need to cut the dividend or else raise funds to keep paying it, for example by selling off assets. That can help prop up a dividend for a few years. But it may reduce the ability of the business to generate free cash flow in future.
That is why many investors were not surprised when Imperial Brands slashed its dividend in 2020. It had delivered years of double-digit dividend increases. But acquisition debt meant interest payments ate into cash flow. So the dividend cut was widely expected.
Earnings are important, but not in isolation. I use a price-to-earnings ratio as one of a number of valuation metrics. But dividends rely on free cash flow, not the accounting measure of earnings. I think focussing on companies whose dividends are covered by free cash flow can help me earn more passive income in future by hopefully dodging some painful dividend cuts.
4. Pay attention to special dividends
Sometimes companies are doing particularly well or have an unexpected cash infusion, for example from the sale of a business unit. They may see that as a one-off event. So they may not want to use it to boost the dividend, only to have to cut it back the following year. Instead, they can pay it out as what is called a ‘special dividend’.
The unpredictable nature of special dividends means that some information sources exclude them when calculating a company’s dividend yield. But they can be substantial. Paying close attention to them could help me identify passive income ideas with higher yields than I realised, that I otherwise might have ignored.
Take the miner Rio Tinto for example. It declares the dividends on its London-listed shares in dollars. Last year, of a total $5.57 in dividends, $0.93 was in special dividends. Two years before, the special dividend of $2.43 was around 44% of the total dividend payout of $5.50. If I was looking at information that excluded the special dividend when calculating the Rio Tinto yield, I would not have realised fully how attractive its passive income potential was for me.
5. Sell shares after a big price rise
In general, if I buy shares in a high-quality company I am happy to hold them for years. I do not pay too much attention to the twists and turns of the share price. But that is because when investing, I am often focussed at least partly on long-term share price growth prospects, not just on income.
If my focus was purely on increasing my passive income, though, I might be more active trading my shares once their price increased a lot. As an example, imagine I had invested £1,000 in ExxonMobil last February when it was yielding around 7.8%. Since then, Exxon shares have increased approximately 63% in price. If I simply kept the shares I would expect roughly £80 in dividends in the coming year, after a modest increase last year. But if I sold the shares, I would receive roughly £1,630 due to the share price rise. If I invested that in shares yielding today what the Exxon shares did when I bought them in this example (7.8%), my dividend income in the coming year should be around £127.
