My passive income portfolio is key to my being able to keep reducing my working commitments as I grow older.
This is because it features stocks that deliver very high dividends each year. Better still, this is done with minimal ongoing effort from me – hence the ‘passive income’ label.
The income stream can not only be used to make a much more comfortable and/or early retirement. It can also be used on an ongoing basis when younger to improve the quality of life.
Consequently, I am always on the lookout for stocks that meet my three key criteria for inclusion in this portfolio. And I think I have found another.
A very high yield
FTSE 250 investment management firm Man Group (LSE: EMG) paid a dividend last year of 17 cents. That was fixed at a Sterling equivalent of 12.8p, giving a current dividend yield of 8.1%.
By comparison, the current average yield of the FTSE 100 is just 3.4% and of the FTSE 250 only 3.3%.
It also well exceeds my minimum 7% dividend yield criteria for my passive income portfolio. This figure reflects that I can get 4.6% from the ‘risk-free rate’ (the 10-year UK government bond yield). As shares are not risk-free, the additional yield is my compensation for taking that chance.
A very undervalued share price
I also ensure that any such stocks I buy are at least 30% underpriced to their fair value.
The more a stock is undervalued, the less chance there is of it seeing sustained price losses, in my experience. This comprises several years as a senior investment bank trader and decades as a private investor.
Experience has also taught me that the best way to determine value is through a discounted cash flow (DCF) analysis.
The DCF for Man Group shows its shares are 36% undervalued at their current £1.59 price. Therefore, their fair value is £2.48.
Very high earnings growth potential
My final selection criterion is that the business must have annual earnings growth potential of at least 2% above the risk-free rate.
If it does not, then the management would be better off selling off all its assets and investing the proceeds in the 10-year UK government bond. And I would be broadly better off sticking my money in it, rather than in the firm.
Moreover, it is ultimately earnings growth that drives any firm’s share price and dividends higher over time.
A risk to Man Group’s is intense competition in the sector.
However, consensus analysts’ forecasts are that its earnings will grow by a whopping 32.7% a year to end-2027!
Will I buy it?
£10,000 invested in 8.1%-yielding Man Group shares should make me £12,418 in dividends after 10 years. And after 30 years, this could rise to £102,665.
Adding in my initial £10,000 stake, a Man Group holding could be worth £112,665 by then. And this could pay me an annual passive (dividend) income of £9,126 at that point!
This is based on the dividends being reinvested back into the stock – known as ‘dividend compounding’.
It is also based on the 8.1% yield average. However, analysts forecast that this will rise to 8.5% this year, 8.9% next year, and 9.5% in 2027.
Consequently, I will buy the stock very soon indeed.
