Buying cheap shares could help set me up for sizable passive income streams. Right now, fortunately, I think there are some very attractive shares trading cheaply in the London market.
If I had a spare £300 a month to invest and wanted to aim for a second income of over £2,000 a month on average down the line, here is what I would do.
Buying shares for income
To begin, let me explain how buying shares could help me generate passive income.
Some companies use their profits to help fund a dividend to shareholders. Such dividends are never guaranteed. But if I can build a portfolio of shares that pay me dividends in future, I could use it to build a second income.
Targeting a big payout
As an example, imagine I put £300 each month into shares for the next 30 years.
That might sound like a long time. However, I think really powerful financial results come from adopting a long-term approach to investing.
Imagine I could achieve an average dividend yield of 7% and reinvested those dividends (something known as compounding) rather than taking them out as cash.
After 30 years, my portfolio would be worth £350,000. It would hopefully be generating £24,567 annually as a second income for me.
Finding shares to buy
My secret weapon in putting such a plan into action? Cheap shares.
By cheap, I do not necessarily mean ones with a low price. Rather, I would be looking for shares I felt potentially offered me significantly more value in the long term than I would need to pay for them today.
Digging into value
The thing is, sometimes shares may be cheap for a reason.
Diversified Energy with its 24% yield may seem like a bargain. But can the company continue that mammoth payout? Perhaps. It does own tens of thousands of gas wells that could help it generate sizeable revenues. But it also carries a lot of debt and its business model could suffer if energy prices fall.
So when looking for cheap shares to buy, my focus is on the quality of the business concerned and what I reckon its future earnings might be.
Only after finding what I think is a great business do I consider its share price and valuation.
Taking action to earn
The good news is that I do think a 7% average yield is achievable in today’s market, even while sticking to blue-chip companies.
From my own portfolio, I own FTSE 100 shares like M&G with a yield above 7%. I also own FTSE 250 shares with a 7%+ plus annual yield, like ITV.
But as no dividend is ever guaranteed, I make sure to maintain diversification across a range of shares.
Bargain hunting in 2024
Some such companies look like very cheap shares to me right now.
ITV, for example, is trading on a single digit price-to-earnings ratio. Before buying more, I would consider the risks as well as potential rewards. For example, a slowing advertising market could hurt profits.
But I think buying the right cheap shares today with a spare few hundred pounds each month could help me set up a sizeable second income for future.
