Passive income is money one receives without working for it. Its popularity has grown, in part due to the increase in digital nomads seeking lifestyle independence. But the idea isn’t as daft as it might sound – all sorts of people have earned passive income for centuries, from landowners collecting rent to shareholders receiving dividends. Shares are a classic form of passive income provider. Here are two shares I hold as passive income streams.
The economics of passive income streams
I like tobacco shares to generate passive income for a specific reason. Industries that are young and growing often have high capital expenditure, research, or sales costs. That can mean that instead of distributing profits to shareholders, they need to plough them back into the business. By contrast, tobacco is a highly cash generative, mature industry. So instead of needing to put profits into building the business, they can be shared with shareholders.
One of my own passive income streams is thus my shareholding in British American Tobacco (LSE: BATS). This is a large tobacco company with a worldwide footprint. It is the owner of iconic cigarette brands such as Lucky Strike and Camel. But the company also has an eye on the future, with its vaping brand Vuse and heated tobacco brand Glo.
BAT has raised dividends each year for over 20 years, and last week announced that it would again raise its dividend, this time by 2.5%. The dividend remains covered by the company’s earnings, although its debt pile of almost £40bn could act as a limiter on its ability to keep increasing its dividend in future.
Despite the dividend increase, the market didn’t respond well to the results. The shares have drifted down to the point where they yield over 8%, which is one of the highest yields among FTSE 100 shares. That is why it is one of my passive income streams – the quarterly dividend payouts come my way without me having to work for them. The company does face business headwinds, including tobacco declining in many markets, and the growing popularity of ethical investing. As a result, I don’t know how much longer the dividends will continue at their current level.
Another passive income stream
One tobacco company that did cut its dividend, last year, is Imperial Brands (LSE: IMB). Despite that, this British company is yielding 9.9%. That is why it is one of my passive income streams.
Imperial recently unveiled a new strategy focused on shoring up its cigarette business in its five biggest markets. So while like BAT it is also developing what it calls next generation products, its focus is more clearly on making the most of cigarettes while they last. That means it has more eggs in one basket, which could explain why the City did not respond enthusiastically to the new strategy.
Imperial also doesn’t have quite as attractive a mix of brands as BAT in my opinion. BAT’s acquisition of Reynolds several years back gave it massive scale in the high margin American business, which Imperial lacks.
Nonetheless, the shares are offering close to a double-digit yield to shareholders for no work at all – that’s real passive income. Diversification helps lower my risk, so tobacco is just one part of my portfolio. But both these tobacco shares are agreeable passive income streams for me.
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christopherruane owns shares of British American Tobacco and Imperial Brands. The Motley Fool UK has recommended Imperial Brands. 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.