When hunting for stocks to buy for passive income, I try not to look at yield alone. Yes, it’s the most direct metric that determines how much I could earn, but it shouldn’t be relied upon alone.
Often, high yields are unsustainable and end up leading investors into a dreaded ‘dividend trap’. Soon after purchase, the company slashes dividends and the investor’s left with a bag of worthless shares.
So when I see companies with yields of 8% or more, I first take a closer look. And it pays off because, on a few rare occasions, I find some that are actually worth considering. Here are two of them.
The up-and-coming REIT
NewRiver REIT (LSE:NRR) is a small (£307m) UK real estate investment trust that focuses on retail and community assets. Earnings are up 54% year-on-year, yet the shares still look cheap, trading on a forward price-to-earnings (P/E) ratio of just 8.9.
That suggests the market’s sceptical about the outlook for smaller property players, but the fundamentals are moving in the right direction.
For income seekers, its financial metrics are impressive: a meaty 9.2% dividend yield with a payout ratio of 97.2%. For most companies that would look dangerously high, but REITs are designed to distribute the bulk of their profits, so this isn’t unusual.
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Crucially, NewRiver’s paid dividends uninterrupted for 15 years and currently has enough cash to cover the payouts, which adds comfort.
The risk? The balance sheet’s a little stretched, with total debt exceeding equity. That doesn’t make it uninvestable, but it does mean investors should watch borrowing levels and refinancing costs carefully. If earnings continue to rise, a fresh injection of equity or asset sales could help de‑risk the capital structure.
Until then, this is a high‑yield stock to consider that could reward well for accepting some leverage and sector risk.
Income in the heart of the capital
City of London Investment Group (LSE: CLIG) is a global asset manager specialising in closed‑end funds. It offers an 8.55% yield, with a payout ratio of about 106.6%. On the face of it, that’s a bit stretched, but the company has a 12‑year uninterrupted dividend record and about 1.2 times cash coverage, which helps soften the concern.
Earnings are heading the right way, up 11.6% year-on-year, and the shares look sensibly priced, with a P/E growth (PEG) ratio around 1. That suggests the valuation roughly matches its growth prospects, rather than relying on heroic assumptions.
The balance sheet is another plus: a very low debt‑to‑equity ratio of 0.03 drastically reduces the risk of a debt‑driven dividend cut.
The main risk here is that performance is tied to global markets and investor sentiment. A sharp downturn would impact the company’s assets under management (AUM), hurting fee income and the share price in one go.
For that reason, it’s best considered as part of a diversified income basket rather than a lone selection.
A risk/reward balance
While both these stocks have lower dividend coverage than I’d usually consider sufficient, their track records and balance sheets add comfort.
Still, when talking about yields above 8%, there’s always a higher risk of cuts. Both could certainly give a nice boost to an income portfolio’s average yield, keeping in mind the importance of diversification.
