Who is better positioned to make money by selling things online? Proven retail operator Dunelm (post-tax profits last year: £171m) — or me? The answer seems obvious. Yet when it comes to generating passive income, many people try to do things themselves rather than leave it to the experts.
Instead, I use my Stocks and Shares ISA to buy stakes in companies like Dunelm. I then sit back, hoping they will generate profits and pay dividends to shareholders such as myself.
Here is how I would go about doing that with a £20,000 ISA.
Go where the money is!
Dunelm is able to pay out dividends because it generates more cash than it needs to run its business. Some companies, by contrast, are profitable but do not make shareholder payouts. Frasers Group, for example, has made a profit in four of the last five years but has not paid a dividend in any of them.
So I would focus on finding companies I expect to generate profits in future and pay out to shareholders regularly.
An example is Unilever. It makes household products like shampoo for which there should be resilient demand. Owning unique brands such as TRESemmé gives it pricing power. That can help support profits, which came in at €6.6bn after tax last year. Currently, Unilever pays out a quarterly dividend.
How to think about yield
But the past is not necessarily a guide to what will happen next. So no matter how promising I thought one company was, I would diversify my Stocks and Shares ISA across a range of firms.
I would also invest in different sectors. I like Reckitt for similar reasons to Unilever. But just buying consumer goods shares still does not give me the sort of diversification I use as a way to manage my risk. So I would invest in a variety of industries, always sticking to ones I understood.
How could I know whether I would hit my passive income target? That depends on the average dividend yield of my £20,000 portfolio. Yield is an indication of what percentage of my investment I ought to earn per year as dividends. For example, Reckitt’s yield is currently 3%. That means if I invest £100 in Reckitt shares today and it maintains its dividend, I ought to earn £3 per year.
Yield is a guide to what I could earn. I do not use it as a compass for finding shares to buy. Instead of looking for high-yield shares, I hunt for companies with a competitive advantage in an enduring market. Only then do I consider yield.
Aiming for my target
A weekly passive income of £30 on average is an annual total of £1,560. To earn that by investing a £20,000 Stocks and Shares ISA, I would need an average yield of 7.8%.
That is quite high – more than double the yield of Unilever and Reckitt, for example. As it is an average, I could invest in companies with a lower yield as long as the average still came out at the right level.
To do so, I would take my time. I am willing to wait for the right opportunity to buy high-quality companies at an attractive price – and hopefully hit my passive income target.
