£10,000 in savings? Here are 3 stocks I’d consider to earn passive income

This writer explains how dividend stocks can help to create an additional passive income stream and details three picks he likes.

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Dividend-paying stocks with strong fundamentals and a positive future outlook (as well as a good dividend track record) can help build a solid passive income stream. However, it is important to note that dividends are not guaranteed.

Three stocks that flagged up as potential additions to my portfolio are Paragon Banking Group (LSE: PAG), Smiths News (LSE: SNWS) and Alumasc Group (LSE: ALU).

These three options deserve a closer look, and here’s why!

Some background (and risks)

Paragon Banking Group is, unsurprisingly, a bank. In 2024, the economy might not grow very quickly, and interest rates could be high. This, combined with the ongoing high cost of living, will make things tough. It will be similar to 2023 in terms of uncertainty, but each year has its own difficulties. Financial companies will need to adjust to pressure from different factors.

Smiths News is a distributor of newspapers, magazines, books and consumables. Management has raised caution that revenues may fall 3-5% in the medium term. But the company’s large market share and history of cutting costs well make the revenue issue just a small one, in my opinion.

Alumasc Group is a UK-based supplier of building and engineering products. As well as grappling with ongoing inflation, the industry is facing increased volatility in material prices. I think this poses as the biggest threat to the industry in 2024.

The metrics

“The higher the dividend yield, the better.” Not so fast! Many beginner investors searching for passive income can fall into the trap of this thinking. A high dividend yield is nice, but there are other factors to consider.

Therefore, I use a few filters to find dividend shares that could be great contributors in the long term. The first of which is looking at the share-price increase over the last 12 months.

If a share price falls dramatically, the dividend yield will increase significantly. However, the increase is not due to strong underlying fundamentals. In fact, it’s likely the opposite: weak fundamentals. Therefore, I look to avoid artificially high yields.

From my three selected companies, the 12-month performance is:

Alumasc: +11.2%
Paragon Banking Group: +29.3%
Smiths News: +1.0%

The second filter is focused on the company’s three-year free cash flow. Free cash flow is a key metric that helps a business function day to day, and supports income payments to investors without hampering operations.

To meet my criteria, a company has to have this metric above 10%. The figures are as follows:

Alumasc: 13.4%
Paragon Banking Group: 32.0%
Smiths News: 32.7%

The final part of my criteria is the dividend history. I want to find companies that aren’t stalling in dividend payments, but rather are growing them over the past few years.

All three companies tick this box. Their dividends are in line with or higher than their five-year average.

I’ll also add a fourth metric to the mix, because you may be wondering about this one. I look for a trailing 12-month (TTM) dividend yield above 4.5%.

The TTM dividend for my basket of dividend stocks is 6.4%. Smiths News leads the way with 8.8%, Alumasc with 6.0% and Paragon with 4.5%.

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.

Jesse Williamson has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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