Image source: Getty Images
The easiest way I've found to make money with little effort – 'passive income' – is from dividend payouts.
I started buying such stocks 30 years ago now, but at first it was better in my opinion. Why? First, the longer the period, the more likely the market will be able to recover from any major shock. The same applies to individual stocks.
From its launch on 3 January 1984 to 3 January 2024, i FTSE 100 increased by 670%. This does not include dividends paid by stocks during that period or the effect of 'dividend compounding' on these returns.
This is when the dividends paid are used to buy other shares they paid for. It's the same idea as compound interest on a bank account, and it effectively charges fees.
Common income share?
I bought it BT (LSE: BT.A) share recently based on three key factors.
Firstly, at the current price of £1.36, last year's 8p dividend yields an annual yield of 5.9% per annum. This already compares very well with the current FTSE 100 payout ratio of 3.7%.
I also think BT's yield is likely to rise, as dividends (and share price) are driven by the company's earnings growth over time.
The biggest risk for this company is the intense competition in the telecommunications sector. Indeed, the 20th of August saw the competitor of Sky announce the launch of broadband services on the network of the Internet provider CityFibre.
However, consensus analyst estimates are that BT's earnings will increase by 12.2% each year until the end of 2026. These healthy growth prospects are the second reason to buy the stock.
Third is that the current £1.36 share price looks 75% undervalued to me on a discounted cash flow basis. This means a fair value of the shares of £5.44.
It could be lower or higher than that, of course. But such small valuations reduce the chance that my dividend gains will be wiped out by continuing share price declines.
How much money can be made?
£11,000 (average UK savings) invested in BT shares will now make £649 in dividends in the first year, assuming no change in payout. Over 10 years at the same rate of 5.9%, this will rise to £6,490, and after 30 years to £19,470.
Not bad, sure, but nowhere near what can be done when dividend compounding is considered.
Doing this at equal yields would give me an extra £8,815 after 10 years, not £6,490. And after 30 years, I would have made an extra £53,300 instead of £19,470!
Adding to the initial stake of £11,000, the total investment in BT would be worth £64,300. That will pay £3,794 a year in income over that period.
Inflation would have reduced the purchasing power of that currency by then, of course. And there may be tax consequences, depending on individual circumstances.
However, it strongly emphasizes how much annual income can be generated over time by investing in high-yielding stocks and compounding dividends.
Source link
