Start earning passive income with UK dividend stocks

Owning stocks can be a great way to earn extra income. But what should investors look for? Stephen Wright outlines what makes a great investment opportunity.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Older couple walking in park

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

According to Warren Buffett, if you don’t find a way to make money while you sleep, you will work until you die. Buying stocks that generate income is a great way of doing the first and avoiding the second. 

Figuring out which shares to buy can be challenging and there are traps to avoid everywhere. But there are a few things investors can look for.

Quality

One of the most important things when it comes to investing for passive income is finding a quality company. This means two things. 

First and foremost, it means the business has the ability to generate significant amounts of cash. If it doesn’t do this, it isn’t going to provide passive income to its shareholders. 

Equally important, however, is finding an organisation that doesn’t have high ongoing costs. The more it costs to run, the less of its cash is available to investors.

One terrific example of this is Rightmove. As an online platform, it doesn’t have significant equipment maintenance costs, which allows it to return a lot of its cash to its owners.

In 2022, the business generated £198m in cash through its operations. And the capital expenditures came in at less than 1.5% of this, leaving the rest available as free cash.

Moat

A business that generates a lot of cash is great. But it’s important it has some advantage over its competitors – what Buffett calls an economic moat.

Without a moat, even a great company won’t be a good passive income investment for long. Rivals will start doing something similar, disrupting its cash generation.

There are different types of moat. A size advantage, a low cost of production, or a network effect can be a competitive advantage.

AstraZeneca is a great example of a UK business with an economic moat. Of the drug manufacturer’s 30 medicines, 25 are under patent, effectively preventing copying from competitors.

With this kind of moat, it’s also important that the company has a good pipeline. In order to maintain strong cash flows, the firm needs more drugs coming through to replace expiring patents.

Price

Finding great stocks is only half of the challenge, though. The other half is buying them at a decent price.

No business can generate an infinite amount of cash. This means it’s always possible to make a bad investment by paying too much for a stock.

Whether or not a a company’s shares are good value comes down to two things. The first is its price and the second is the amount of cash it will distribute to its owners in the future.

Diploma, for example, has a share price of £27 and paid out £45p in dividends per share last year. That’s a 1.7% return, which isn’t hugely impressive.

The business is growing, though. Over the last decade, Diploma’s dividend payments have increased by 12% per year, so future returns look set to be higher than the current ones.

Passive income 

Buying stocks for passive income is simple, but not easy. There’s a lot to consider and there’s always uncertainty about the future.

Nonetheless, I think there are opportunities in great companies out there. And the UK stock market looks to me like as good a place as any to find them.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright has positions in Diploma Plc and Rightmove Plc. The Motley Fool UK has recommended Rightmove Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Mixed-race female couple enjoying themselves on a walk
Investing Articles

Are Raspberry Pi shares a once-in-a-lifetime chance to get rich?

With Raspberry Pi shares surging after a successful IPO, could this UK tech startup offer a long-term wealth creation opportunity…

Read more »

Newspaper and direction sign with investment options
Investing Articles

Huge gains and 9% yields: why now’s an amazing time to be a stock market investor

The stock market’s generating fantastic returns in 2024. Whether you're looking for gains or income, it’s a great time to…

Read more »

Hand of person putting wood cube block with word VALUE on wooden table
Investing Articles

This steady dividend payer looks like one of the best bargain stocks in the FTSE 100

A yield of 4.7% and a consistent dividend record make this FTSE 100 company look like good value in an…

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

£9,000 in savings? That could become passive income of £19,175 a year

It's possible to invest affordable sums of money into building a big passive income stream. Here's how I'd go about…

Read more »

Black father and two young daughters dancing at home
Investing Articles

Legal & General shares: a once-in-a-decade passive income opportunity?

Is a dividend yield at its highest level in a decade, combined with a strong record of increasing payouts, a…

Read more »

Investing Articles

With a 7% yield and 4.1 P/E, is this the best passive income stock on the FTSE 350?

Millions of Britons invest for a passive income. While our writer isn't buying this stock yet, he believes it's worth…

Read more »

Middle-aged Caucasian woman deep in thought while looking out of the window
Investing Articles

This amazing FTSE 250 has a 8.8% dividend yield and trades at just 4x forward earnings!

Our Foolish writer believes this FTSE 250 stock is worth keeping a very close eye on. However, he's not keen…

Read more »

Portrait of elderly man wearing white denim shirt and glasses looking up with hand on chin. Thoughtful senior entrepreneur, studio shot against grey background.
Investing Articles

Could this brilliant airline stock be the most undervalued company on the FTSE 100?

Our writer believes this FTSE 100 stock may provide market-beating returns over the coming years, noting its undervalued metrics and…

Read more »