The best easy access Cash ISA on the market at the moment offers an interest rate of just 0.6%. With that in mind, I think investors would be better off buying FTSE 100 stocks to generate a passive income.
FTSE 100 stocks for income
Two companies in the UK’s blue-chip index stand out to me as being undervalued income investments. Mining groups BHP (LSE: BHP) and Rio Tinto (LSE: RIO) are some of the world’s largest producers of crucial commodities such as iron ore and copper.
The mining sector might not be the first place investors look for income investments. However, these FTSE 100 stocks have become some of the market’s best dividend stocks during the past few years.
Their transition started a few years ago. After an extended period of excessive spending, when the mining industry collectively wasted hundreds of billions of dollars on vanity projects, many of which never recouped the cost of construction, BHP and Rio decided enough was enough.
Their respective management teams took decisive action to lower costs and reduce spending. This coincided with a significant increase in the prices of essential commodities. As a result, profit margins expanded, and profits jumped.
By reducing spending on capital projects, these FTSE 100 companies were able to use the extra profit to reduce debt. And after paying off borrowing, the firms switched to rewarding investors.
Following the switch away from debt reduction to dividend growth, both BHP and Rio have since become dividend champions. Today, shares in the two companies support dividend yields around 6%. That’s around double the FTSE 100 average.
I think these dividends are here to stay for the foreseeable future. Governments around the world are in the process of commissioning massive infrastructure programmes, which are designed to stimulate economic growth following the pandemic. This is already having a significant impact on commodity prices. The prices of copper and iron ore, for example, are pushing to multi-year highs.
This suggests that BHP and Rio could see a substantial increase in sales and profits this year. At the same time, both companies have been investing in efficiency measures, such as automated trains, which should lower their transportation and production costs.
I believe these twin tailwinds of rising sales and growing profit margins will lead to larger profits, and, as a result, bigger dividends for investors.
There could also be the chance of a special dividend or share buyback if the FTSE 100 firms end up with too much cash on their balance sheets.
The bottom line
All in all, at a time when so many other companies are struggling, and with interest rates at record lows, I think Rio and BHP could boost one’s portfolio. Their dividends alone are worth investing in, in my view, that’s without taking into account the potential for capital growth.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.