There are two key reasons why I have been focusing on stocks that generate high passive income.
First, the FTSE 100 is at the same price now as it was in March 2017. Consequently, price-growth opportunities have become more limited than when the index was consistently rising over time.
Second, I want my money to go where it is best rewarded for the associated risks. As global interest rates have risen, many high-quality assets will reward me with high yields for buying them.
Even UK government 10-year bonds currently yield 4.6%. The current average yield for the FTSE 100 is 3.9%.
This said, I also want companies with strong businesses, and the likelihood, in my view, of share price gains. After all, I do not want my yield returns cancelled out by share price losses.
Crisis valuations but no crisis
From around the middle of Q1, a broad-based sell-off in UK financial stocks caught my eye.
The sale resulted from fears that the failure of US-based Silicon Valley Bank might spark another global financial crisis. These jitters were compounded shortly after with the failure of Credit Suisse.
To me, these fears and this sell-off looked unwarranted. After the 2007 crisis, capitalisation throughout the UK’s financial system was dramatically strengthened and regular liquidity checks are conducted.
Yet many stocks remain at prices much lower than they were before the sell-off.
The onset of a genuine major financial crisis does remain a risk for such shares, of course. Another is that inflation and interest rates remain high, acting as a deterrent to new-client business.
However, I believe several financial stocks are exceptional businesses at exceptional prices offering exceptional yields.
‘Big Four’ bank NatWest (LSE: NWG) paid a total dividend last year of 30.3p per share. Based on a current share price of £2.06, this gives a whopping yield of 14.7%. A £10,000 investment at this rate would make an additional £1,470 in passive income in a year.
Part of the overall payment last year was a special dividend, so it may not repeated, of course.
Either way, the stock also looks undervalued to its peers on a price-to-earnings (P/E) ratio basis. NatWest’s is 4.2 against a peer group average of 5.65 – comprised of Barclays (3.6), Lloyds (4.8), HSBC Holdings (6), and Standard Chartered (8.2).
The stock is down 34% from its 2 February high this year.
Legal & General
Financial services and asset manager Legal & General (LSE: LGEN) looks even more undervalued, trading at a P/E of 6.1. It has dropped 23% this year.
This compares to Prudential’s 8, Hansard Global’s 11.1, Admiral’s 20.2, and Beazley’s 27.6 – giving a peer group average of 16.7.
Last year, the total dividend was 19.37p per share. Based on the current share price of £2.06, this gives a yield of 9.4%. A £10,000 investment at this rate would make an additional £970 in passive income in a year.
The average yield of the two shares — which I hold — is 12.05%. A total £20,000 investment in them at that rate would make an additional £2,410 in passive income per year. This is over and above share price gains or losses and tax obligations incurred.