If I wanted a small but steady passive income, a great place to start would be stocks that offer dividend payouts. And here in the UK, I have an abundance of strong income stocks to choose from. Let’s say I wanted to make £100 a month. Here’s a fantastic stock I could use to try and achieve that.
£100 a month
British insurance and pensions provider Legal & General (LSE: LGEN) is one of those income stocks that offer a ‘pound in your pocket’ return rather than the uncertainty of the rises and falls of the stock market. The company currently returns 7.3% to its shareholders in its annual yield.
If I bought 6,477 shares of Legal & General then that 7.3% yield would return £1,200 a year. That gives me a round £100 each month. Like most stocks, the dividends are typically paid out twice per year rather than monthly and the actual return varies and isn’t guaranteed.
How much would those shares cost? Well, right now I’d have to spend about £16,438 in total. I don’t have that kind of money lying around, but I can work towards it.
If I could save £400 a month then I’d build up that total in roughly 41 months. But I could speed up the process by reinvesting the dividends, which would mean I could build up that amount in only 37 months. So that’s about three years of saving to create a £1,200 yearly income. A tidy return, when put like that.
But it’s important to look at the risks too. And the obvious risk here is the dividend payout. Just how likely is it to continue in the future?
A risky dividend?
The first step I can take to see if a dividend is likely to maintain its value is to look at past performance. Here’s the annual yield for Legal & General over the last five years.
| 2021 | 2020 | 2019 | 2018 | 2017 | |
| Annual yield | 6.2% | 6.6% | 5.8% | 7.1% | 5.6% |
I can see that the yield has been a touch lower than the current 7.3% dividend, which indicates it may come down in the future. However, a strong payout during the 2020 Covid crisis shows Legal & General is committed to making payments to its shareholders, as many other companies reduced or cancelled the dividend for that year. But the yield alone doesn’t tell the full story.
Another useful piece of information is the percentage of earnings used for dividend payouts. A rule of thumb is that less than 60% means the company isn’t spending too much on dividends.
| 2021 | 2020 | 2019 | 2018 | 2017 | |
| % of earnings | 54% | 79% | 57% | 55% | 50% |
So this is more good news. The company has rarely spent above 60% of its earnings on dividends to shareholders, which means those payouts are likely to be sustainable without impacting the company too much. The 79% in 2020 was a result of Covid, which should be a one-off.
Of course, this is still no guarantee of the future when unpredictable events may affect the dividend payout. In 2008 and 2009, for example, the firm cut its dividend considerably. And I have to take into account potential losses through the share price itself. Overall though, I like the stock for its passive income potential and will be looking to open a position soon.
