Here’s how investors could consider aiming for £3,449 in annual passive income from £10,000 of HSBC shares

Relatively small investments in high-yielding shares can grow into big passive income, especially if the dividends are reinvested in the stocks.

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Making money from financial investments is the truest form of passive income there is, in my view. Passive income means earnings generated with minimal effort, such as with dividends from shares or interest from bonds.

The only real effort involved is picking the right share or bond in the first place and then monitoring its progress periodically.

Much excitement has been seen recently from a spike in UK government bond yields. Those yields have jumped to around 4.7% on the benchmark 10-year bond, known as the ‘risk-free rate’.

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As I have large holdings of these, I am as happy as the next bondholder. However, this does not mean that I will be moving all my money currently in stocks into these.

Shares chosen for their passive income potential can generate much greater returns than UK government bonds even now.

Three qualities I want in passive income stocks

The first thing I want in passive income stocks is a yield significantly higher than the 10-year UK government bond. As a stock’s yield moves in the opposite direction to its price, this will change frequently.

The second quality I look for is that a share seems very undervalued to me. This reduces the chance of my making a loss on the stock should I ever wish to sell it. This would effectively diminish the overall passive income I had made on the share.

And the third element I require is that the business is strong enough to keep paying the high dividends.

A prime example of these factors at play

On the first element, I bought HSBC (LSE: HSBA) shares when they yielded well over 7%. As the share price has soared since then, the yield has gone down to 5.9% now. That said, this has been more than compensated for by gains in the stock price if I wished to sell them.

On the second, a discounted cash flow analysis shows the shares are technically 55% undervalued, even after their rise. Given their present £8.24 price, the fair value for them would be £18.31. Market vagaries might push them lower or higher than that, but they still look full of value to me.

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And finally on business strength, a risk is that the recent decline in UK interest rates will reduce its net interest income. This is the difference between a bank’s income from interest charged on loans and paid out on deposits.

However, HSBC has shifted its strategy from interest-based to fee-based income. This resulted in Q3’s pre-tax profit rising 9.9% to $8.48bn (£6.95bn), way ahead of analysts’ consensus of $7.6bn.

How much passive income can be made?

Investors considering a £10,000 stake in HSBC would make £8,014 in dividends after 10 years. And after 30 years, this would have risen to £48,454.

By then, the total HSBC holding would be worth £58,454, which would pay an annual passive income of £3,449.

This is based on ‘dividend compounding’ being used and on an average 5.9% yield over the periods. Analysts forecast the yield will rise to 6.7% in 2025, 6.9% in 2026, and 7% in 2027 but there is no guarantee it will.

Given that all three factors that led me to buy in the first place are still in play, I will be buying more HSBC shares very soon.

Of course, there are plenty of other passive income opportunities to explore. And these may be even more lucrative:

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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.

Simon Watkins has positions in HSBC Holdings. The Motley Fool UK has recommended HSBC Holdings. 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.

Like buying £1 for 51p

This seems ridiculous, but we almost never see shares looking this cheap. Yet this recent ‘Best Buy Now’ has a price/book ratio of 0.51. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 51p they invest!

Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.

What’s more, it currently boasts a stellar dividend yield of around 8.5%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?

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