Despite the FTSE 100 reaching record levels, I think there are still passive income opportunities in UK shares. And one that stands out at the moment is alcohol company Diageo (LSE:DGE).
With 37 years of consecutive increases, the company’s a Dividend Aristocrat. And with the share price close to a 52-week low, right now could be a good time to consider buying the stock.
Dividend income
At today’s prices, investing £10,000 in Diageo would get me 359 shares. And with a dividend yield of just under 3%, I could expect to receive £293 a year for doing pretty much nothing.
That’s without reinvesting the dividends. If I used the cash I received over the next decade to buy more shares, then my returns could potentially be even higher.
Exactly what I might make after a decade by reinvesting in Diageo shares depends on the dividend yield at the time. But at an average of 3%, I could be looking at £593 a year.
Furthermore, things pick up sharply over a longer period. The same assumptions suggest investing £10,000 today could return £1,298 in annual passive income after 20 years and £2,842 after 30 years.
Can it continue?
Of course, nothing’s guaranteed when it comes to dividends. And Diageo’s impressive track record doesn’t entirely eliminate the risk of the dividend being lower in the future.
That’s been particularly relevant recently. Weak demand in the US, Latin America, and the Caribbean have caused sales volumes and profits to fall.
This is why the stock’s fallen 25% over the last 12 months. But management believes the issue’s temporary, and is expecting sales growth of between 5% and 7% over the medium term.
I find this plausible and I don’t see anything intrinsically wrong with the business. But if I’d bought the stock a year ago at £37 per share, I might well be thinking I’d paid too much for it.
Is the dividend in danger?
I don’t believe Diageo’s dividend is in imminent danger of getting cut. The company’s made £2.5bn in free cash over the last 12 months and its distributions to shareholders are around £1.8bn.
If the business underperforms over the next few months, the dividend might increase more slowly than usual. But I’d expect it to keep increasing steadily for some time.
Over the last 37 years, Diageo has endured the Covid-19 pandemic, the Global Financial Crisis, and the dotcom bust. And while it hasn’t been immune to the effects of these events, it has survived.
More than that, the company’s found ways to increase its dividend each year while these things have been happening. So I don’t think a short-term sales downturn is going to disrupt the dividend.
Should I buy Diageo shares?
The lesson from Diageo’s recent share price decline isn’t that the company has lost its way. It’s that even a really good business can be overpriced and that’s something investors need to be careful of.
Right now, the stock’s trading at a much more reasonable valuation. And given the firm’s strong competitive position, it’s a stock I’d consider buying for a decade or more of passive income.
