Dividend stocks are a terrific source of passive income. Even with higher interest rates making savings accounts more attractive, they still pale in comparison to some of the opportunities investors are able to capitalise on. Plus, despite popular belief, dividends don’t have to be reinvested to unlock chunky long-term earnings. In other words, investors can start reaping the rewards straight away. Here’s how.
Investing in a growing yield
Hunting for high-yielding enterprises is a common practice among income investors. After all, the larger the sustainable payout, the more money that will be earned. While that’s true in the short term, in the long run, the landscape changes drastically.
A merely modest yield today can potentially grow into a gargantuan one in the future. A perfect demonstration of this happened with Safestore over the last 13 years. Despite only offering a fairly average yield at the time, investors who bought and held its shares since then are reaping more than 50% returns from dividends alone today!
Therefore, investors should be focused on finding firms with the capacity to grow their payouts over time, regardless of the yield now. And that’s what’s brought Hikma Pharmaceuticals (LSE:HIK) back on my radar.
Dividend potential
It’s been a bit of a bumpy ride for Hikma shareholders these last few years as competition ramped up in its core US market. But since then, management’s focus on expanding its other divisions — like its Injectables segment — has steadily started steering operations back on track, and with it, the share price.
Despite these operational speedbumps, cash flows remained relatively robust, enabling the group to continue increasing dividend payments. As such, it now has an 11-year streak of hiking dividends, with payouts growing at an impressive average of 14.2% per year.
Why is that significant? At the current stock price, the dividend yield stands at a fairly lacklustre 2.9%. As such, investing £9,000 right now would translate into a passive income of just £261 per year. Obviously, that’s hardly anything to get excited about.
But what if the firm continues to increase its payouts over the next 11 years at the same pace? In this scenario, the passive income stream could increase to over £1,100 without having to put any additional capital in.
Risk and uncertainty
Like any investment, dividends come with risks, especially when making predictions about the future. Admittedly, the demand for generic pharmaceuticals isn’t likely to disappear any time soon. After all, critical drugs are coming off patent every year, and healthcare unaffordability in the US, among other places, provides powerful tailwinds for companies like Hikma.
However, the group isn’t operating in a monopoly and has a lot of competition to fend off, as previously mentioned. As such, even if management is able to continue raising payouts over the next decade, it could be at a slower pace than what’s historically been achieved.
Investors must consider the possibility of potentially earning less than expected. Nevertheless, the prospect of making hundreds of extra pounds each year without having to lift a finger or needing to reinvest makes it a risk worth taking, in my opinion. That’s why I’m thinking of adding this business to my portfolio once I have more capital to hand.
