When it comes to harvesting passive income from dividend stocks, I prefer those backed by a defensive business.
By that I mean enterprises that tend to have stable cash flows and earnings. And ones that are affected little by general economic downturns.
At the other end of the spectrum are cyclical companies, such as those found in sectors like retailing, banking, resources and others. Such stocks tend to sport high dividend yields from time to time. But the economics of cyclical businesses can be volatile leading to an unreliable stream of dividends.
One of my first choices
Therefore, my starting point tends to be to look in defensive sectors. And one of the most reliable is the smoking products industry. However, companies operating in the market face high regulatory scrutiny and long-term cigarette volumes are in decline. On top of that, the rising trend towards ethical investing may keep many investors away from stocks in the tobacco game despite attractive-looking financial indicators.
There are some factors to keep an eye on when investing in the sector. Nevertheless, I’d consider British American Tobacco (LSE: BATS) as a dividend investment. And if I had spare cash right now, would aim to buy 342 shares to get £70 a month in passive income from dividends.
City analysts following the firm expect the total dividend to be 246p per share for the year in 2023. And to get my dividend income of £70 a month, I’d need to collect an annual dividend of £840 a year from my BATS shares. Therefore, 342 shares in the company should achieve my goal. And the current share price near £31.30 would require an investment in the shares of £10,705.
But my larger goal would be to diversify between several defensive, dividend-paying shares. And I’d aim to generate a passive income larger than £70 a month. So, the overall investment required would be greater than £10,705.
Compounding gains
The sums involved are quite large. Therefore, I’d aim to build up my investments gradually over time. And to do that I’d invest regular monthly amounts then reinvest the dividend income along the way. The idea would be to compound my gains and build up an investment pot big enough to sustain a larger passive income from dividends later — perhaps when I retire.
I’ve used an online compound interest calculator to get a feel for what’s required. And I’ve assumed it’s possible to get a reliable annual return of 4% from dividends across my portfolio.
If I invest £300 a month and reinvest a 4% yield, the calculator tells me I’d build up to a pot worth over £200,000 after 30 years. But the interesting thing is those £300 monthly sums would add up to just over £100,000 during that time. The rest of the gain will have come from compounding dividend returns.
Of course, this theoretical outcome isn’t guaranteed in practice. Indeed, all shares carry risks as well as positive potential. However, the illustration encourages me to continue with my dividend strategy for the long term.
