There are many ideas out there about how to make money with minimal effort – ‘passive income’ as it is known.
Having tried several myself – most notably through buy-to-let properties – I still think investing in stocks for dividends is the best method.
Generating money here only requires the initial picking of shares and then periodically checking they still look the best choices.
Whether they are depends on three key factors in my 35 years’ experience of doing this.
Key qualities for passive income stocks
The most obvious element required is a high yield. A good benchmark for me is 7%+ at the time of buying a stock. Why this level? Because I can get 4.7% from the ‘risk-free rate’ (the 10-year UK government bond) and shares are not risk-free.
The second quality I want is a stock whose price is undervalued compared to its fair value. This increases the chance of making a share price profit – as well as the yield accrued – if I sell it.
The third is a firm’s earnings growth prospects. It is these that ultimately power both its stock price and dividends higher over time.
A case in point?
One firm that has popped up on my investment radar again recently is FTSE 100 homebuilder Taylor Wimpey (LSE: TW).
In 2024 it paid a dividend of 9.46p, which on the current £1.16 share price yields 8.2%. Analysts estimate this will rise to 8.4% in 2026 and 2027.
On the share price, a discounted cash flow analysis shows the stock is 48% undervalued at its current £1.16. Therefore, the fair value for the shares is £2.23, although market vagaries could move them lower or higher.
And on the final criterion, consensus analysts’ forecasts are that earnings will increase 16.78% a year to end-2027. A risk here is a further rise in the cost of living that may deter new house buying.
However, its 30 April trading update showed its order book rose from £2.1bn to £2.3bn in the year to 27 April. The firm expects 10,400-10,800 full-year 2025 UK home completions compared to 9,972 in 2024.
How much passive income can it make?
Just using the current 8.2% yield and no forecast rises, investors considering a £10,000 holding in Taylor Wimpey would make £820 in dividends this year. Over 10 years on the same average yield this would rise to £8,200 and over 30 years to £24,600.
This is a lot better than could be made from a standard UK savings account, of course. But it could be far greater if the standard investment practice of ‘dividend compounding’ were used.
This just involves reinvesting the dividends paid by a stock back into it. It is like leaving interest to accrue in a bank account.
Doing this on the same average 8.2% yield would make £12,642 in dividends after 10 years not £8,200. And after 30 years on the same basis this would increase to £106,073 rather than £24,600.
The total value of the holding would be £116,073 by then, including the initial £10,000 stake. This would be generating £9,518 in annual passive income from dividends by that point!
My portfolio is already well-balanced so I will not buy but I think it is one that investors should consider now.
