In selecting stocks for their potential to deliver very high passive income I look at three key factors.
First, the yield and other shareholder rewards. Second, the core business. And third, the stock valuation. After all, I do not want my dividend payouts wiped out by share price losses.
Shareholder rewards
Last year, ‘Big Four’ bank NatWest’s (LSE: NWG) total dividend was 30.3p per share. With the stock at £2.27, this gives a whopping yield of just over 13%! This is at the top of the FTSE 100’s yield leaderboard.
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I do note, however, that the dividend cover ratio for this final payout was just 1.2. A ratio above 2 is considered good, while below 1.5 may indicate the risk of a potential dividend cut. So there is a risk here that the dividend might be slashed at some point.
There are other risks in the stock as well, of course. One is that enduring high interest rates cause a major ongoing rise in loans turning bad. Another is a global banking crisis of the sort seen in 2007.
That said, the interim payment for the first half of this year was higher than last year’s 3.5p – at 5.5p. A share buyback programme of up to £500m is also set to begin in H2. This will be in addition to the £1.3bn directed buyback completed in Q2.
Core business
The bank made a pre-tax profit of £3.6bn, compared to £2.6bn in H1 2022.
This was mainly due to its strong ‘net interest rate margin’ (NIM). This is the difference between earnings from loans and payouts for deposits. And this resulted from ongoing high interest rates required to combat rising inflation.
NatWest’s H1 2023 NIM was 3.2%, against 2.58% in H1 last year.
Sure, 6 September saw Bank of England Governor, Andrew Bailey, say it is “much nearer” to ending interest rate rises.
However, this does not preclude them from being raised again. Bailey said in May that the Bank was “nearer” to peak interest rates, and it then increased them in June and August.
Additionally, senior Bank officials have stressed that even if rates are close to peaking, they are unlikely to fall quickly.
Stock valuation
Currently, NatWest is trading at a price-to-earnings (P/E) ratio of 4.7. Barclays trades at 4, Lloyds at 4.8, HSBC Holdings at 6, and Standard Chartered at 8.5. And all these FTSE 100 banks trail the benchmark index’s present average P/E of 10.8.
This suggests to me that NatWest stock is currently undervalued.
I have another holding in the UK bank sector in my portfolio. But I am considering adding NatWest, principally for its passive income potential but also for possible share price gains.
If I invested £10,000 now in the stock, then I could potentially expect £1,300 per year in passive income. Over 10 years, that would add £13,000 to my initial £10,000 investment.
And this would not include any gains I made from possible share price appreciation. On the other hand, it would not include deductions for tax or for any share price losses either.
