HSBC (LSE: HSBA) remains a core holding in my ‘passive income’ portfolio, designed to maximise my returns from dividend stocks.
Aside from choosing the shares to invest in and monitoring their progress, no other effort is required on my part – hence the ‘passive’ label.
Picking the right shares
The first quality I want in my passive income stocks is a high dividend yield. HSBC paid out 61 cents (48p) a share last year, yielding 7.7% currently. This compares very favourably to the FTSE 100’s present average of 3.6%, so one box ticked for me.
The second thing I look for is the shares to be undervalued against their peers. This reduces the chance of my dividends being erased by extended share price losses.
A discounted cash flow analysis shows HSBC’s shares to be 62% undervalued at their present price of £6.25. Therefore, a fair value would be £16.45. They may go lower or higher than that, but to me it is another box ticked.
The final factor I require is good business growth prospects, as this powers dividends over the long term. Analysts estimate that HSBC’s revenue will grow 5.1% a year to end-2026. The final box ticked, as far as I am concerned.
How much passive income can it generate?
A share’s yield changes as its price moves and as its dividend payments change. Currently HSBC pays 7.7% a year, but analysts forecast this will rise to 9.7% by the end of this year.
However, there are risks in the business, as in all firms. The main one I see for the bank is that the margin it makes between deposits and loans shrinks in line with falling UK interest rates.
That said, in its H1 2024 interim results released on 31 July, HSBC’s pre-tax profit fell just 0.4% to $21.6bn. This was better than consensus analysts’ expectations of $20.5bn. Additionally positive was the $0.4bn increase in revenue compared to H1 2023.
It also pledged a $3bn share buyback, with such programmes tending to support share prices. And it paid a second interim dividend of 10 cents. This followed the same amount paid at the end of Q1 and a special dividend of 21 cents announced on 30 April.
Using the lower yield of 7.7%, £10,000 of HSBC shares would generate £770 in dividends in the first year.
Over 10 years, an extra £7,700 would be made, provided the yield averaged the same. Over 30 years on the same basis, this would total £23,100.
Turbocharging the dividend returns
This all assumes that the dividend payments are withdrawn each year and spent on something else.
Crucially though, if they were used to buy more HSBC shares instead, the gains could be much, much more.
Doing just this (‘dividend compounding’ as it is called) would make an extra £11,545 after 10 years instead of £7,700.
After 30 years of reinvesting the dividends, an additional £90,004 of passive income would have been generated rather than £23,100.
The total investment pot of £100,004 would pay £7,700 a year in dividend payments, or £642 every month!
Assuming inflation over the periods, the buying power of the income would be reduced, of course. However, it underlines how much passive income can be made from much smaller investments over time.
