To earn long-term passive income, we need to look for a stock with a high dividend yield, right?
Well, a high yield means more income. But no dividend is guaranteed, so we need to take care.
For example, earlier this year the forecast Burberry Group dividend was up at 7%. But my Motley Fool colleague Stephen Wright wrote that “it would be a brave investor who banks on that being sustained if things don’t look up for the underlying business“.
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A few days later, the company posted an update saying that “we have decided to suspend dividend payments in respect of FY25.” The yield dropped to zero percent.
And telecoms giant Vodafone had been offering a fat 10% dividend, but it slashed it by half for next year.
Cut the risk
How do we minimise the risk of this kind of damage? I see two key ways.
One is through diversification, putting our money into a range of companies in different sectors. Imagine having all our money in banks when they slashed their dividends in the 2020 stock market crash, for example. We don’t want that.
My second approach to reducing risk is to seek companies that are in solid long-term businesses. Ones that don’t need huge amounts of capital expenditure, and aren’t led my fashion and fickle sentiment.
My example today is abrdn (LSE: ABDN), the FTSE 250 investment manager, with a forecast 8.8% yield.
Finance risk
An investment like this is clearly not without risk, and it can be hurt by poor economic times. Just look at the above chart to see how the last few years of high inflation and interest rates have hit the abrdn share price.
The company did drop its dividend by a third in the 2020 crash year. But it kept it going each year since. And with the share price down, I think it could be a strong long-term passive income investment now.
But there is one other caution. Forecast earnings won’t cover the dividend for the next couple of years, and that’s generally not good.
Still, the investment business is harder to judge by the usual valuation criteria than some.
Check the cash
And with abrdn’s H1 update in August, the company reported “Adjusted capital generation up 1% to £144m driven by higher adjusted profit after tax. Covers interim dividend 1.11 times. (H1 2023: 1.04 times)“.
So the cash seems to be there, with cover improving. And analysts expect the firm to maintain current dividend levels at least until 2026.
After that, I’d hope the investment business would be back to strength, and we could hope to see dividends growing again.
No-brainer?
With the risks I’ve outlined, no, abrdn isn’t a no-brainer buy for me. But it does satisfy some of the key criteria I always consider with passive income stocks.
It’s in a business with strong potential long-term cash generation. The dividend yield is good, and cover is forecast to improve.
And the share price has fallen to what I think is undervaluation, meaning I could lock in better dividend yields if I buy while it’s low. I might just do that.
