When I initially started building my passive income portfolio, I was disheartened. I found it difficult to maintain a high average yield, and often got stuck holding bad stocks after the company cut dividends.
I felt it would take forever to save enough to achieve meaningful returns. And I was impatient. So I made a promise to cut my daily costs by at least £10, saving £300 a month to invest.
Then I started picking better stocks with lower, but more sustainable, yields. I found that by making good choices, I could realistically maintain an average yield around 7%.
Calculating returns
By my calculations, I would need around £171,000 to bring in £12,000 a year in dividends — my target. Divided by £10 a day (£3,650 a year), that would take me 46 years to save. Sufficient for a 20 year-old, but far too long for my needs.
Fortunately, by reinvesting dividends and harnessing the miracle of compounding returns, I could slash this time in half!
I calculated that if my averages hold, I could reach around £170,000 in 21 years. That’s sufficient to hit my goal before retirement.
So what are these ‘sustainable’ dividend stocks?
Identifying reliable dividend stocks
For investors interested in this strategy, heres an example of how I identify sustainable dividend stocks.
First, I screen for stocks with 10-plus years of payments, a payout ratio of 50%-90%, and sufficient cash coverage. Critically, I check the balance sheet to ensure debt is manageable. High debt is often the first reason that dividends get cut.
The FTSE 250 price comparison site MONY Group (LSE: MONY) is a good example. It has a 6.7% yield, an 81% payout ratio, and 18 years of uninterrupted payments. Its balance sheet is very healthy, with £229m in equity far outweighing £45m of debt.
It’s also highly profitable, with a return on equity (ROE) of 37.2% — a level usually only seen in leading growth stocks. With steady earnings growth of around 8% year-on-year, the 186p share price now looks 45% undervalued, based on future cash flow estimates.
But the company operates in a crowded, highly-competitive price comparison market where differentiation is challenging. This may be one reason the share price is down 29% in the past five years. However, the stock grew 314% in the 10 years prior to Covid, suggesting it does well during times of economic prosperity.
Final thoughts
With consumer confidence at eight-month highs and GDP expected to rise 1.4% GDP, MONY Group could benefit. Lower interest rates are boosting household spending power, driving demand for its financial products. Its lean operations position it well to capitalise on renewed consumer activity.
Despite macroeconomic uncertainty, I think it’s still worth considering for a beginner passive income portfolio. However, it should only be included as part of a larger diversified portfolio consisting of between 10 and 20 holdings.
While it’s good practice to focus on industries you’re familiar with, it’s equally important to reduce sector-specific risk by including some outliers. Investors can find a wide range of other income stocks on the UK market that offer similar sustainable characteristics.
