I’ve been looking for stocks to buy that could start me off on a passive income journey. And I’ve found two UK shares that I think fit the bill.
Generating dividend income is like building a snowball. It starts off small, but with enough of a runway, it can get bigger and bigger.
That means I’m looking for two things. The first is a company that pays a dividend to its shareholders and the second is business with a good chance of doing this for some time.
With that in mind, here are the UK shares I’d use to start a dividend snowball. Neither has a big dividend yield right now, but I think both have growth prospects going forward.
InterContinental Hotels
Top of my list is InterContinental Hotels Group (LSE:IHG). The stock currently has a dividend yield of around 1.8%, which means that a £1,000 investment today would yield £18 in dividend income.
That’s not a lot, but the company has been increasing its dividend at a significant rate. Over the last five years, IHG’s dividend per share has grown by an average of 6.5% per year.
If that growth rate continues, then my £1,000 investment today will be paying £32 per year after 10 years. And after 30 years, I’ll be earning an annual return on my initial investment of over 11%.
The biggest risk here is the company’s dividend payment hasn’t always been consistent. During the pandemic, IHG stopped its dividend entirely.
Since then, though, the dividend has gone from 90p per share in 2019 to £1.05. And the company’s business model gives me confidence it can keep growing in future.
Operating on a franchise model allows IHG to keep its costs low. That means the company can distribute a lot of its earnings to its shareholders.
Diploma
I also think that Diploma (LSE:DPLM) could be a great stock to start building a dividend snowball with. Like IHG, the dividend yield is just under 2%, but it has been achieving impressive growth.
Diploma has been growing its dividend at 16% per year for the last five years. At that rate, a £1,000 investment today would generate £35 after five years and a 19% annual return after 30 years.
The real question – and the risk – concerns Diploma’s ability to maintain those growth rates. While 16% growth is demanding, I think the company’s size means it has a long growth runway ahead.
With a market cap of under £3.5bn, the company should be able to grow by acquiring other businesses. And its existing subsidiaries are also posting impressive organic growth.
Like IHG, Diploma has a business model that allows it to return significant amounts of its cash to investors. Around 76% of the company’s operating earnings become free cash flow.
Stocks to buy
Both InterContinental Hotels Group and Diploma have business models that allow them to pay significant dividends. And I think both have decent prospects for increasing their returns over time.
I already own Diploma shares in my portfolio, but I don’t yet own IHG stock. Right now, though, both are firmly on my list of stocks to buy when I have the cash to do so.
