A common way to generate passive income is earning dividends from shares in blue-chip companies. Doing that means I can benefit from the hard work and commercial acumen of well-established firms with proven business models.
If I had £8,900 in spare cash or savings today, here is how I would use it to generate a passive income.
Understanding the plan
The approach here is simple, in my view. My target is passive income. So I would buy shares I thought would likely pay large dividends in coming years. My focus would not be on share price growth, although when investing I would still take care valuing companies so hopefully I do not overpay.
I would invest in a few different companies to spread my risk. A target of £8,900 is ample for that. My first move would be setting up a share-dealing account or Stocks and Shares ISA and putting my money into it.
Finding shares to buy
When it came to choosing income shares for my portfolio, I would stick to industries I understood and felt I could understand.
An example of a share I would happily buy at the moment if I had spare cash to invest is Hollywood Bowl (LSE: BOWL). The market for leisure activities is sizeable and I expect that to remain the case over time.
As a leading operator of bowling alleys, Hollywood Bowl has a competitive edge in that market, from prime locations to economies of scale. It also operates mini-golf centres.
That has been a recipe for success, with the first half seeing post-tax profit of £22m on revenue of £119m. That is an impressive net profit margin in my view… 18! That profit helps fund dividends and, at the moment, the dividend yield is 3.7%.
The interim dividend grew 22% compared to last year. During the pandemic though, the dividend was cancelled. That highlights an ongoing risk I see for Hollywood Bowl, that any sudden slowdown in the entertainment sector could eat badly into profits. As a long-term investor though, I like the business and would be happy to own a piece of it.
Building income streams
The Hollywood Bowl yield of 3.7% is above the 3.3% average for the FTSE 250 index of which the company forms part.
Still, I believe I could hit a markedly higher yield – say 7% — while sticking to blue-chip FTSE 100 and FTSE 250 firms that meet the criteria I illustrated in my view of Hollywood Bowl.
If I invested £8,900 at an average yield of 7%, I should earn £623 of passive income a year.
As we are already over halfway through 2024, I would not expect that much this year. But I ought to earn it next year — and every year afterwards while I hold the shares, if the companies I invest in maintain their dividends.
If they cut them, I could earn less – but hopefully choosing the right businesses could actually mean I benefit from growing passive income streams over time.
