Earning some extra passive income is one of my goals for 2023. The idea of receiving money without requiring much of my time sounds attractive.
I can think of multiple ways to earn passive income, but my favourite idea right now is to own dividend shares.
By owning shares in a dividend-paying company, I’m entitled to a portion of its profits. This is often paid in cash to shareholders on a quarterly basis.
Steady passive income
There are several benefits to owning dividend shares. First, it offers a steady stream of passive income. Some companies have consistently been making cash payments to shareholders for years, and some even for decades.
That’s exactly the type of reliable income that I’m looking for.
In addition, some businesses have also managed to grow their dividends over time. Having income that grows over time can help with the rising cost of living. This is has become much more apparent with inflation soaring in the past few years.
Next, as companies grow and earn more, the value of my shares could increase. This creates the potential for capital gains over time.
Picking the best dividend shares
To find the best dividend-paying shares that are suitable for passive income, I’d start by narrowing down my options.
There are hundreds of shares listed on the London Stock Exchange, and even buying half of them would be impractical.
First, I’d start with the dividend yield. The average yield for the FTSE 100 is currently 3.6%. But many shares offer over 6%. That’s where I’d focus my search.
Although some shares can distribute as much as 12%, I’d be cautious of companies that offer extremely high dividend yields. It can often be a red flag, warning of an upcoming cut to payouts.
Next, I’d look at its dividend cover. This is a popular measure of safety, and it looks at how many times a company’s dividend can be covered by its earnings.
Although I’d consider a dividend cover above 1.2, I would prefer a figure greater than two, as that would provide a greater margin of safety.
Reducing risk
Next, I want to see how many years a company has been paying dividends. The greater this figure, the more confidence it gives me. For the lowest-risk passive income, I’d look for a dividend history of at least five years.
Once I’ve filtered down the list of stocks, it’s time to start picking the very best. To do this, I’d research the companies to see what they do and how they make money.
It’s a good idea to own a diversified portfolio of shares, in my opinion. That’s why I try to pick a range of companies from different industries. This should avoid putting all my eggs in one basket and limit my risk.
The best passive income shares that I’d buy right now are Phoenix Group Holdings, Glencore, Legal & General Group, British American Tobacco, and Sainsbury (J).
Each of these shares operates in a different sector. On average, this group also offers a 7.3% yield, a healthy dividend cover of 1.9, and 22 years of consecutive dividend payments.
That all sounds appealing to me.
