Passive income shares are those that pay shareholders a dividend and therefore help us earn a passive income. This part is obvious, but it can be trickier to choose the right passive income stocks.
My checklist
The first thing we need to do is look at the dividend yield. It shows us what percentage of a company’s share price is paid out in dividends each year. Large dividends are attractive, but a huge dividend is often a danger sign.
One way we can identify stocks with dangerously unsustainable dividends is by using the dividend coverage ratio. This tells us how many times a company can pay its stated dividends from its earnings.
It’s simple to work out. For example, if the company’s expected to earn 3p per share and the stated dividend is 1p per share, then the dividend coverage ratio is three.
Traditionally, investors look for a dividend coverage ratio of two — this is the benchmark for a healthy dividend. But I often make exceptions for companies in booming industries and strong cash flows.
Nordic American Tankers
Experts had been warning for some time that the tanker industry wasn’t building enough ships. Several factors prevented leasing rates from skyrocketing after the pandemic. But that’s no longer the case.
The global tanker fleet is the oldest in living memory, and new deliveries are at their lowest in almost four decades. In fact, just two supertankers will be delivered this year — that’s 90% lower than the average for the last two decades.
Nordic American Tankers (NYSE:NAT) is one company that’s prospering from the supply and demand imbalance. It has a small fleet of 20 Suezmax tankers and provides investors with an 11.9% dividend yield.
It’s one of the strongest dividend yields I’ve come across, but the dividend coverage ratio could be stronger. Based on projected earnings, the coverage ratio is around 1.26.
However, I’m slightly more optimistic on earnings for the year. See, the company’s actually benefitting from the Red Sea disruption. Because ships that normally go through the Suez Canal — Suezmax is the largest tanker to go through — are being rerouted all the way around Africa to avoid the Houthis, Nordic’s fleet’s in demand.
I, like the company’s management, accept that an end to hostilities in the Middle East would result in leasing rates falling. But I don’t see that happening right now. Leasing rates are above $40,000 a day and they’re staying there.
TBC Bank
If you hadn’t notice, UK-listed Georgian banks have performed very well in recent years. TBC Bank (LSE:TBCG) is up 213% over three years and currently offers a 7.2% dividend yield.
Georgian banks are soaring because they were vastly undervalued due to concerns about the pandemic and Russia’s invasion of Ukraine somehow spilling over, and the Georgian economy in overdrive. Banks are cyclical and tend to reflect the health of the economy.
The dividend is likely to be covered around 2.7 times by earnings, which is very strong. However, as much as I like TBC and its peers, I’m holding off until after the parliamentary election in October.
Georgia’s political scene is heavily polarised and a recent controversial security law resulted in 10 days of demonstrations.
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James Fox has positions in Nordic American Tankers Limited. The Motley Fool UK has no position in any of the shares mentioned. 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.
