Earning passive income from the stock market is a popular way to secure financial freedom. But, what kind of shares could help investors like me achieve this ambition?
Fortunately, plenty of stocks listed in the FTSE 100 and FTSE 250 indexes distribute a portion of their profits to shareholders via dividends. Although no company’s cash payouts are guaranteed, many investors have successfully used dividend investing to amass substantial fortunes.
So, let’s explore how I could use a spare £5,000 to bag £1,000 in annual passive income by investing in one leading blue-chip dividend stock.
A juicy yield
News about AI stocks might dominate the headlines currently. However, income investors shouldn’t overlook more traditional businesses amid the hype. For instance, bank shares often pay healthy dividends.
Take HSBC (LSE:HSBA) for example. The FTSE 100’s largest bank measured by market cap offers a chunky 7.9% dividend yield at present. What’s more, the lender’s forecast yield is even higher at a whopping 10.7%! This is a stock that merits serious consideration in my view.
Quick mental arithmeticians will notice that a £5k investment in HSBC shares would only yield £535 a year in passive income. So, how could I reach my coveted £1k figure?
Well, at The Motley Fool, we advocate taking a long-term approach to investing. Using HSBC’s forward yield, by pursuing a dividend reinvestment strategy, I could expect my shareholding to yield a four-figure sum in just over six years.
Granted, that assumption rests on the 10.7% yield remaining unchanged over the time period, which may not happen in reality.
However, I’ve also not accounted for potential growth in the HSBC share price. Accordingly, my journey to a £1k passive income stream could take more or less time, depending on how the shares fluctuate in value.
Understanding the risks
Like any stock, HSBC carries risks. On the bright side, the bank posted a record annual pre-tax profit of $30.3bn in 2023 — a 78% rise on the previous year. This headline figure looks impressive, but it’s worth digging deeper into the detail.
The final quarter was a challenging one. A $3bn charge on its stake in a Chinese bank dealt a nasty blow. As a result, HSBC missed analysts’ expectations for a full-year pre-tax profit of $34bn.
There’s also good reason to exercise caution about the dividend. Forecast cover of 1.6 times earnings is below the two times level that’s traditionally viewed as a comfortable margin of safety.
Nonetheless, the stock’s forward price-to-earnings (P/E) ratio of 6.4 is below the FTSE 100 average. This bodes well for future growth prospects. It also suggests many of the risks the bank faces are reflected in today’s share price.
Diversification
A good way to mitigate portfolio risk is diversifying across different companies and sectors. Indeed, there are many other high-yield UK stocks for investors to choose from.
Some examples to consider might include British American Tobacco with a 10.1% yield, insurance provider Phoenix Group Holdings with a 10.6% yield, and NextEnergy Solar Fund with a 10.9% yield.
By building a solid portfolio of dividend shares comprised of HSBC and the likes of those listed above, earning a healthy passive income stream is a realistic (albeit not risk-free) ambition that investors can consider.
