Making money with minimal daily effort — ‘passive income’ — may seem like wishful thinking to many. But that is precisely what dividend‑paying shares deliver.
The only effort involved is picking the right stocks in the first place and then periodically monitoring their progress thereafter.
So, what sort of stock do I look for, and how much could I make from it?
Why a 7% minimum yield?
Every stock I choose for my passive income portfolio has at least a 7% yield at the time of selection. I do this to give myself compensation for taking the additional risk of share investment over no risk at all. And I can get 4.9% from investing in 10-year UK gilts right now — the ‘risk-free rate’.
Analysts forecast that Aviva’s (LSE: AV) dividend yield will rise to 6.5% this year, 7% next year, and 7.4% in 2028. That said, these returns can go down as well as up over time.
So, £20,000 (the same as my holding) invested in the shares would make £162,896 after 30 years. This period is widely seen as the standard investment cycle for long-term investors, such as me. It starts with first investments aged around 20 and ends in early retirement options around 50.
The numbers assume the forecast 7.4% as an average, and that the dividends are reinvested back into the stock — ‘dividend compounding’.
At the end of 30 years, the holding’s total value (including the £20,000 original investment) would be £182,896. And this would pay a yearly income from dividends alone of £13,534!
How underpriced to ‘fair value’ is it?
Discounted cash flow (DCF) analysis attempts to determine what a stock is truly worth by forecasting future cash flows and discounting them to today’s value. When those forecasts are less uncertain, investors demand higher returns, which increases the discount applied.
Analysts’ DCF models differ because they rely on different assumptions. Using my own approach — including a 7.2% discount rate — Aviva looks 47% undervalued at its present £6.27 price.
That suggests a fair value of £11.83, nearly double where it trades now. If markets continue to close this price-to-value gap over time, this could be an excellent opportunity to make share price gains on top of dividend income, if those DCF assumptions hold.
Is strong earnings growth forecast?
A risk to Aviva’s earnings growth — the key long-term driver for share price and dividend gains — is a prolonged downturn in financial markets. This could reduce fee income from its investment and savings products.
Another is any regulatory change that could squeeze its margins and limit profit expansion.
Nevertheless, analysts forecast that Aviva’s earnings will grow a strong 14.5% a year on average over the medium term.
My investment view
Such earnings momentum looks more than sufficient to support strong dividend and share price gains over time, in my view. So, I will buy more of the stock very soon.
I also have my eye on more deeply underpriced, very high-yielding stocks in other sectors too.
