FTSE 100 asset manager M&G (LSE: MNG) remains a core holding in my passive income portfolio. This comprises stocks selected to generate high dividends without me having to do too much.
Such income can greatly enhance the quality of life and can also allow for an early retirement. So I look for three key qualities in the shares I select for this purpose.
Yield
The first of these elements is a yield of over 7% when I buy it. This will change as the share price and annual dividend alter. However, 7%+ gives me compensation for taking the extra risk in shares over the benchmark ‘risk-free rate’. This is the yield of the 10-year UK government bond, presently 4.6%.
M&G ticks this box for me, having paid a dividend of 20.1p last year, giving a yield of 7.8%. That said, analysts forecast that the payout will rise to 20.7p this year, 21.2p next year, and 22p in 2027.
These would generate respective yields on the current £2.59 share price of 8%, 8.2% and 8.5%.
Undervaluation
The second facet is a stock that is at least 30% underpriced to its ‘fair value’. This value is what the share is worth, based on the underlying business, while price is simply what the market is willing to pay.
Such an undervaluation minimises the chance I will lose money on the share price if I sell. Conversely, of course, it increases the chance of making money in that event.
The 30% figure reflects my experience that anything less can be wiped out by high market volatility.
M&G again ticks this box for me, with a discounted cash flow valuation showing it is 46% undervalued now. Therefore, its fair value is £4.80.
Earnings
That said, the powerhouse of a company’s dividends and share price is earnings growth (or profits). Whereas revenue is the total income a firm makes, earnings are what remain after expenses are deducted.
Given this, I want as high a figure as possible, but 6% is my absolute minimum when I buy. I think if a firm cannot achieve this then it might as well sell its assets and put them in the risk-free bond.
A risk for M&G is a surge in the cost of living that might cause clients to cancel their policies. That said, consensus analysts’ projections are that its earnings will grow by 41% a year to the end of 2027.
What does this mean for passive income?
Ignoring the higher yield forecasts, £11,000 (the average UK savings) of 7.8%-yielding M&G shares would make £12,936 in dividends after 10 years. After 30 years on the same basis, this would rise to £102,332.
Both figures assume that the dividends are reinvested back into the stock – known as dividend compounding.
Adding in the £11,000 initial investment, the M&G holding would be worth £113,332 by that point. And this would pay an annual passive income of £8,840 by then!
Will I buy more of the shares?
I do not doubt that the very strong forecast earnings will drive the share price and dividend much higher. This, given the already extremely high yield and extremely low valuation, means I will buy more shares very shortly.
