Stocks that earn me passive income — in the form of dividends — look very attractive right now. It’s not just that being paid for merely owning a slice of a company sounds rather lovely. Knowing that I should receive this cash regardless of where share prices go next is another attraction at a time when the cost of living can’t stop rising.
But what to buy? Well, here are what I believe to be two great candidates from the FTSE 100.
King of drinks
Not all dividend stocks are equal. Some promise huge payments that end up never being paid because a company struggles to afford them. Personally, I prefer to stick with those offering a lower but more predictable stream of passive income.
With this in mind, one of my favourite FTSE 100 companies remains premium spirits purveyor Diageo (LSE: DGE). Its huge portfolio of over 200 brands includes many of the most popular drinks in the world. Guinness? Check. Johnnie Walker whisky? Check. Smirnoff vodka? Yep, that too.
Of course, stocks offering passive income aren’t necessarily any safer than those that don’t. In tough times, those cash returns can be shelved as a company looks to save money where it can.
Will this happen with Diageo?
I’m not convinced. While higher prices may push some drinkers to seek cheaper alternatives, I also doubt they’ll stick with them when the UK economy thrives again. So, even if earnings do take a hit, the recovery — when it inevitably does arrive — will be even stronger.
A 2.2% dividend yield looks small, but Diageo has shown itself to be startlingly reliable when it comes to raising payouts every year. It’s this attribute that makes the company — expensive though its shares are — stand out even more.
Chunky yield
Another FTSE 100 stock that I reckon offers a compelling stream of never-guaranteed-but-as-reliable-as-you’re-probably-going-to-get passive income is Legal & General (LSE: LGEN). The investment manager and insurance giant has a solid record of paying more and more cash back over time. Given the importance of getting our finances in place for our golden years (and Legal’s role in assisting us in doing this), I don’t think that trend is about to reverse.
As I type, Legal & General shares come with a 6.8% yield. Doesn’t this go against my previous point of not going for the big-payers? Actually, no. This is because dividends are currently expected to be easily covered by profit this year.
Sure, there are headwinds. Trading might be impacted by a sustained recession and the inability of some to invest for retirement.
Nevertheless, the shares already look cheap (eight times forecast earnings). I can also reduce some risk by being invested in other, unrelated sectors. Diageo, for example!
I’m not spending my passive income
One final point. As tempting as it can be to put any passive income I receive towards living costs right now, I’m really trying to avoid it.
A far better use of dividends, in my view, is to reinvest them. Theoretically, this will help my portfolio to grow at a quicker rate (more shares = more passive income).
In time, this will also allow me to benefit from the wonder that is compound interest.
And that’s when things get really tasty.
