With inflation set to soar again in the coming months, a steady stream of passive income would sure come in handy for many. After all, rising dividends can help offset rising costs – a bit like getting a pay rise without asking your boss for one!
Here, I want to look at how realistic it would be for someone to aim (over time) for the equivalent of £100 a day in passive income from dividend stocks.
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Caveats
The first thing to mention is that companies don’t pay dividends weekly, let alone daily. Most do so either quarterly or bi-annually. So when I say £100 a day in passive income, I’m talking about the equivalent of that spread across a year.
Furthermore, individual dividends are never guaranteed. Even the most seemingly reliable payers — such as Tesco and FTSE 100 banks — have cancelled their distributions at one time or another.
Therefore, it’s essential to build a diversified income portfolio. This way, it would still pay out income even if one or two of the shares in the portfolio disappoint.
It certainly helps one to sleep better at night knowing a portfolio is well diversified (especially one large enough to generate £36,500 a year).
Avoiding traps
With these caveats out of the way, how long would it take to build this level of income? Well, that would depend on the dividend yield.
For example, an ISA with a 3.5% yield would need to be worth a stonking £1.04m. Whereas one yielding 6% would ‘only’ need to be valued at roughly £608,000.
Now, this immediately creates a danger because novice investors might be tempted to invest in ultra-high-yield stocks, for example, those yielding 10%+. But these are often what’s called a ‘yield trap’.
In other words, there’s usually a good reason why the yield is so high. Usually, the stock has fallen a lot because the market is pricing in some forthcoming financial problems, and therefore a potential dividend cut.
All that glitters is not gold!
It’s possible
While income is tax-free inside an ISA, the annual contribution limit is £20,000. Therefore, it will naturally take time to build up to a substantial portfolio value.
However, it’s possible given enough time. For instance, investing £720 a month would grow to around £608k in 23 years, assuming an average annual return of 8.5% with dividends reinvested.
This is the stock market’s ballpark return long term, so isn’t some daft unrealistic target.
5%-yielding stock
One stock that I think is worth assessing is Hollywood Bowl (LSE:BOWL). Listed in the FTSE 250, this is the UK and Canada’s largest ten-pin bowling operator.
There are a number of reasons I like this stock:
- A leading market-position
- International expansion opportunity beyond Canada
- Consistent profitability (proven business model)
- Well-run management team
- Strong balance sheet
- Range of offerings, including food and drink, amusement arcades, and mini-golf
Moreover, the valuation looks cheap to me today, with the stock trading at just 11 times next year’s forecast earnings. There’s also a forward dividend yield of 5.1% — well above the FTSE 250 average.
The main near-term risk I see relates to rising inflation, which could heap more pressure on consumers.
But over the long run, I expect the factors listed above to come to the fore, leaving Hollywood Bowl in a strong position to deliver attractive long-term returns.
