Passive income can sound appealing. But some passive income ideas can seem plain daft! Spending lots of time and energy to set up a wacky business is hardly passive. By contrast, for passive income I prefer to tuck money away regularly in a Stocks and Shares ISA. Every time a company I own pays a dividend, I earn some passive income. Here are some of the passive income ideas I would pick today.
Passive income ideas from regular dividend payers
A key principle when hunting for passive income ideas is finding shares that pay dividends consistently.
The last few months have shown that even high-quality companies can pause, reduce, or cancel their dividends when market conditions worsen. That doesn’t make for the sort of reliable passive income I prefer. So I would look for companies with a long, uninterrupted history of dividend payments.
For example, Unilever, Diageo, and British American Tobacco have each paid their dividend consistently for many years. The financial crisis didn’t stop them and neither did the pandemic. That makes me feel more confident that they will endeavour to sustain their dividend in future.
Not all yields are equal
Looking further into those sorts of passive income ideas, the return on investment through dividends looks different. Take, as an example, Spirax-Sarco. This engineering firm has a well-deserved reputation as a consistent dividend payer. It has been raising its dividends annually for 50 years. However, the market has priced that in and the shares only yield around 1%. So while the dividend history is excellent, I don’t see the share as a good source of passive income.
By contrast, British American Tobacco yields around 7%. That means that if I invested £5 a day into a SIPP and used it to buy the company’s shares, within a year I should have shares producing around £140 in passive income from this tobacco stalwart.
I’d look for strong cash flow cover
Of course, just because a company has paid out a dividend in the past doesn’t mean it will do so in the future. One way I try to pick passive income ideas is by choosing shares that should be able sustain dividends. I do this by projecting future prospects for the industry. If a company has a strong place in an industry which is set to continue or grow, that could be a sound basis for it to continue paying dividends.
Financial commentators often focus on how well a company’s earnings cover its dividends. But companies pay dividends from cash rather than earnings, so in the long term what matters is whether the company’s cash flow can cover dividends. This is not an arcane accounting principle, but an important factor for passive income hunters to understand.
So I also hunt for shares that cover their dividends well from cash flow. That’s one reason I do not have a position in Vodafone, for example. Although it has a high yield at over 6%, the telecoms industry often has high capital requirements that can eat into cashflow. The company already cut its dividend in 2019. Without the right cash flows, it could do so again in the future.
It’s possible to generate passive income with £5 a day. But it helps to know where to look!
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christopherruane owns shares of British American Tobacco. The Motley Fool UK has recommended Diageo and Unilever. 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.