I look for three main qualities in stocks I choose for my passive income portfolio. First, a 7%+ yield, as I get 4%+ from 10-year UK government bonds — the ‘risk-free rate’ – and shares are not risk free.
Second, undervaluation. This reduces the chance that share price losses will erase my dividend gains should I wish to sell the stock. It also increases the chances of me making a profit on the stock price in that event.
And third, an underlying business set for strong earnings growth. It is ultimately this that powers a company’s dividend and share price higher over time.
My three top passive income holdings
Over 50 now, I focus on stocks that can generate high passive income so I can reduce my working commitments.
Three of them have the perfect combination of the key qualities I want in such a stock, in my view.
In order of current yield, they are Phoenix Group Holdings (LSE: PHNX), M&G (LSE: MNG), and Legal & General (LSE: LGEN).
Phoenix Group presently yields 10.2%, M&G 10%, and Legal & General 8.9%.
On the key discounted cash flow (DCF) valuation measure, Legal & General is the most undervalued – by 57% at £2.29. Therefore, a fair value for it is £5.33, although it may go lower or higher due to the vagaries of the market. The same applies to the following stock’s fair values as well, of course.
M&G’s DCF valuation shows it is underpriced at £1.98 by 55%, with a fair value of £4.40. And Phoenix Group is undervalued by 18% on a DCF basis at £5.14, with a fair value of £6.27.
Finally, for earnings growth each year to the end of 2026, analysts forecast Phoenix Group’s at 75%, M&G’s at 30.4%, and Legal & General’s at 29.6%.
How much passive income can they make me?
A principal risk for Phoenix Group is the intense competition in its sector that may squeeze its profit margins. For M&G it is any significant spike in financial market volatility that may make sustained investment gains harder to achieve. And for Legal & General, it is a resurgence in the cost of living that may cause customers to cancel policies.
That said, investors considering taking a £10,000 holding in each – around the same as I have – could make huge returns over time. This is provided they use the dividends to buy more of the stock that paid them, as I do. This is ‘dividend compounding’.
Based on an average 10.2% yield for Phoenix Group, £17,613 of passive income would have been made after 10 years and £200,535 after 30 years.
On an average 10% for M&G, these respective returns would be £17,070 and £188,374.
And on an average 8.9% for Legal & General, these respective dividends would be £14,271 and £132,984.
Assuming inflation over the period, the buying power of the income would be reduced somewhat. Even with this, though, I think these investments will make my later years a lot more comfortable than they would have been without them.
The post These are my top 3 superstar passive income stocks going into 2025! appeared first on The Motley Fool UK.
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Simon Watkins has positions in Legal & General Group Plc, M&g Plc, and Phoenix Group Plc. The Motley Fool UK has recommended M&g 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.
