It’s really very simple. Making passive income from dividend stocks, that is. The FTSE 100 is littered with these stocks that return cash through regular dividends, special dividends or share buybacks.
I choose a target, say £1,000 a month, and reverse-engineer how many shares to buy and how much it costs me.
And while no one has a crystal ball, City analysts can clue me in on whether my income will rise or fall, for a few years at least.
Like I said, targeting £1,000 a month’s simple. But there’s a snag. One bad stock could ruin my plans.
Value traps
Bad companies make bad investments, that much is obvious. But passive income stocks often catch unsuspecting victims off guard.
Take Vodafone. The telecoms giant pays an 11.6% dividend yield, the highest cash return across every company on the FTSE 100. Sounds pretty good.
Except the company’s struggling. Debt levels are high. The telecoms firm can’t keep up with competitors. It’s even selling off operations in Germany, Italy and Spain.
I wasn’t surprised when the CEO announced on 15 March the dividend would be slashed in half.
Vodafone to me was a classic ‘value trap’ – a stock that looks cheap on the surface when the reality is anything but.
No one wants to buy a value trap, but sorting the world-class dividend stocks from the lemons is difficult.
Holy grail
Let’s go back to my £1,000 a month target. How might I achieve this goal by spotting one of these top income stocks today?
Well, the holy grail is an increasing dividend. Investors love a rising dividend because more money ends up in their pocket. As the years go by, the income grows ever larger without even doing anything.
That’s true, but the real advantage to a slowly increasing dividend is a sign a company’s performing.
An AJ Bell report from 2007 to 2017 looked at this. It found Footsie firms with 10 years of dividend increases returned 12.6% a year. The others? Just 5.2% a year.
It makes sense. Companies increase dividends when times are good, cash flows are rising and debt levels aren’t weighing them down.
Insurer Legal & General (LSE: LGEN) ticks all those boxes. For these reasons, I bought the shares some time ago.
The dividend yield stands at 8.2%, the sixth-highest return across all FTSE 100 companies.
My £1,000 a month target requires 58,997 shares – a £145,722 outlay. Of course, that’s a lot of money. But compared to buying a similarly-priced house or flat that I could rent out, I’d rather have the £12,000 a year truly passive income stream.
The latest forecasts expect payments to rise too – £1,051 a month in 2024 and £1,108 a month in 2025.
This century
And while L&G cut dividends during the pandemic, I still believe the stock is a quality-increasing dividend.
It’s increased every year this century except two and the dividend growth is an average 8.14% over the last decade (even including the pandemic cut).
The risks for this company include interest rates reducing the value of its assets and a stagnating share price. There are no free lunches in the stock market, of course.
On balance though, I’d start looking at this FTSE 100 stock to target a £1,000 passive income a month or anything else.
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John Fieldsend has positions in Legal & General Group Plc. The Motley Fool UK has recommended Aj Bell Plc and Vodafone Group Public. 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.
