Passive income is money made from minimal effort. I aim to maximise this to further reduce my working commitments, aged over 50 as I am.
The best way I have found to do so is by investing in shares that pay high dividends. And one of my top stocks in this regard remains the FTSE 100 investment management firm M&G (LSE: MNG).
How much passive income can be made?
In 2023, it paid a 19.7p dividend. On the current share price of £1.95, this yields 10.1%.
By comparison, the average yield of the FTSE 100 is just 3.5% and of the FTSE 250 only 3.3%.
So, £6,000 (just over half the average UK savings amount) would generate £606 in dividends in the first year. On the same average yield, these payouts would rise to £6,060 over 10 years – more than doubling the initial investment. And over 30 years on the same average yield, the dividends paid would be £18,180.
The miracle of dividend compounding
This is a lot better than could be made from a standard UK savings account. But it could be even higher if the dividends were used to buy more M&G shares.
This is known as ‘dividend compounding’ and is a similar idea to letting interest accumulate in a bank account.
Doing this on the same average 10.1% yield would generate £10,404 in dividend payments after 10 years, not £6,060. After 30 years on the same basis, the dividend payments would increase to £116,619 rather than £18,180.
Adding the initial £6,000 investment would make the M&G investment worth £122,619.
Based on the same 10.1% average yield, this would generate £12,385 in passive income every year or £1,032 each month.
Are these high dividends sustainable?
Ultimately, a firm’s earnings drives its dividends (and share price). A risk here for M&G is the high degree of competition in the sector that might squeeze its profit margins. Another is a resurgence in the cost of living that might cause customers to close their accounts.
However, consensus analysts’ estimates are that its earnings will grow a stunning 28.5% a year to the end of 2026.
Consequently, the forecasts are also for a rise in its dividends over the period. Specifically, projections are for dividends of 20.1p this year, 20.6p next year, and 21.3p in 2026.
On the current £1.95 share price, this gives respective yields of 10.3%, 10.6%, and 10.9%.
Is the stock undervalued as well?
If I ever wanted to sell the stock, I would not want to do so at a loss, of course. To reduce the chances of this happening, I only ever buy shares that look undervalued compared to their competitors.
A key measure I use to ascertain this is the price-to-book ratio. M&G currently trades at just 1.2 on this measure against an average 3.5 for comparable firms. So it is cheap on this basis.
To ascertain how cheap in cash terms, I ran a discounted cash flow analysis. This shows the stock is 52% undervalued at its present price.
Therefore, a fair value for the shares is £4.06. although they may go lower or higher, given market unpredictability.
Given its very high yield, extreme undervaluation, and exceptional earning growth prospects, I will be buying more of the stock very soon.
The post £6,000 in savings? Here’s how I’d aim to turn that into £1,032 a month of passive income! appeared first on The Motley Fool UK.
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Simon Watkins has positions in M&g 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.
