Diversification is the cornerstone of my passive income investment strategy. Since dividends aren’t guaranteed, I spread my stock market positions across a variety of companies and sectors.
Accordingly, I hope to secure a steady flow of dividend payouts even if some firms that I invest in encounter financial difficulties. Ultimately, going all in on a single stock is an extremely risky approach and one that’s too rich for my blood.
Nonetheless, it’s an interesting thought experiment. What if I could only pick one dividend share to buy? Which stock would I feel most comfortable putting all my cash into?
After serious deliberation, I settled on Europe’s largest defence contractor, BAE Systems (LSE:BA.).
Here’s why.
Dividend reliability
Offering just a 2.3% dividend yield, BAE shares might not be an obvious choice for passive income seekers. Indeed, the company’s yield is lower than the average 3.7% yield across FTSE 100 stocks.
But hear my logic out. If I had to concentrate my entire passive income portfolio in a solitary stock, I’d prioritise dividend stability over a high yield that might not be sustainable over the long term.
In that regard, the weapons manufacturer doesn’t disappoint. It’s a Dividend Aristocrat, boasting an unbroken 30-year streak of growing shareholder distributions.
Most recently, the firm hiked its full-year dividend for 2023 by 11% to 30p. In addition, BAE continues to boost shareholder returns via an ongoing £1.5bn share buyback programme.
Looking ahead, forecast dividend cover looks healthy at 2.1 times earnings. That’s above the two times threshold generally seen as indicating a wide margin of safety. Impressive stuff.
Defensive qualities
I also like the non-cyclical nature of the company’s operations. Many dividend shares rise and fall in accordance with macroeconomic cycles, but BAE’s fortunes are more closely linked to military expenditure by its government clients around the world.
This makes the stock particularly attractive currently, considering the UK economy entered a recession at the end of 2023.
Granted, some investors may have moral concerns about a business that specialises in manufacturing fighter planes, missiles, warships, and munitions.
That’s understandable. However, there’s little denying this sector’s booming at present due to elevated geopolitical risks and the tragic ongoing wars in Ukraine and the Middle East.
Perhaps then it’s unsurprising that the BAE share price has grown 157% over five years. Looking ahead, the firm’s future looks bright too.
Impressive recent contract wins, such as a £4bn order under the AUKUS defence pact for a new generation of nuclear submarines, lifted 2023’s order intake to a record £37.7bn. BAE’s order backlog also stands at an unprecedented high of £69.8bn.
Risks
Despite reasons for optimism, it’s worth noting the company’s forward price-to-earnings (P/E) ratio of 19.4 is higher than its historical average. This might indicate lower future returns.
Furthermore, BAE’s no stranger to controversy. The historic corruption scandal over the Al-Yamamah arms deal with Saudi Arabia springs to mind.
Plus, Indian authorities are currently investigating allegations of “criminal conspiracy” against BAE and Rolls-Royce relating to the procurement of Hawk 115 advanced jet trainers in 2005.
Nevertheless, I believe BAE Systems merits consideration for any investor’s passive income portfolio. It’s right at the top of my own list, but I’d diversify to mitigate the risks.
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Charlie Carman has positions in BAE Systems and Rolls-Royce Plc. The Motley Fool UK has recommended BAE Systems and Rolls-Royce Plc. 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.
