The FTSE 100 is arguably the best stock market index in the world for investors seeking passive income. It’s crammed with old-school blue-chips in sectors such as financial services, mining, tobacco and housebuilding, which may not offer whizzy growth prospects but compensate by paying investors lots of dividends.
The index has just suffered its worst run in four years, and trades almost 5% lower than a month ago. Over 12 months, it’s down 1.95%. That’s disappointing yet also an opportunity.
It means that my favourite dividend income stocks are now trading at lower valuations (and they looked cheap before the recent sell-off, I feel). Better still, their yields have climbed to new highs.
Passive income stocks: our picks
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Out shopping for shares
Incredibly, two financials currently yield around 10%: insurer Phoenix Group Holdings and wealth manager M&G. I’ve taken a close look at both stocks recently, and concluded (to my surprise) that their dividends might be sustainable.
Such things are never guaranteed, of course. If problems in China spread or the US offers a hard economic landing, that could hit total assets under management and their cash flows.
Yet Phoenix and M&G could trim their dividends and still offer investors a decent level of income. I hold M&G shares and may take advantage of recent weakness to buy more.
I’ve done just that with mining giant Glencore. It’s been hit hard by troubles in China, which will further knock commodity prices if they continue. As a result, it now trades at a ridiculously cheap 3.9 times earnings. That low valuation offers some downside protection while it’s currently forecast to yield 8.8%.
I don’t buy tobacco stocks personally but if I did I’d purchase British American Tobacco like a shot. It looks incredible value trading at 6.9 times earnings and yielding 8.45%. I wouldn’t expect much share price growth, but given the addictive nature of smoking those dividends look more solid than most.
Investing this year is just the start
Finally, I’d dial down the risk slightly with utility giant National Grid. Its earnings are regulated and the dividend looks more reliable than most. The share price looks fairly valued trading at 15 times earnings while the yield is nothing to complain about at 5.71% a year.
Let’s say I split an empty £20,000 Stocks and Shares ISA allowance evenly between these five companies, investing £4,000 in each. The average yield across these four stocks is 8.56%. That would set me on course for income totalling £1,712 in the first year alone.
Investing is a long-term game. I’d plough all my dividends straight back into my portfolio, to pick up more stock. After 25 years, my £20k would potentially be worth £155,875. By then, I’d be generating income of £13,335 a year.
That’s not bad from an initial £20,000 investment. Naturally, those dividends could be cut at any time, which would ruin my crude maths. On the other hand, my assumptions don’t allow for any share price growth at all. Over 25 years, I’d assume a fair bit of that.
Also, I’d diversify and spread my risk by purchasing different FTSE 100 dividend shares inside future ISA allowances, generating even more passive income. They may not be as cheap as they are today, though.
