With a fresh £20,000 contribution limit and the UK market continuing to look very cheap relative to elsewhere in the world, I reckon now is as good a time as any to go hunting down stocks for my ISA. As I won’t pay any tax on the cash I receive, I think this is particularly the case if generating passive income is my priority.
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One example of a company I’d consider buying would be BAE Systems (LSE: BA).
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Some may find owning a slice of a defence contractor unpalatable. However, it’s hard to question this FTSE 100 juggernaut’s dividend credentials. Holders have enjoyed year after year of hikes to the income stream.
Yes, the past can only tell us so much. One clear risk is that it’s impossible to guarantee that BAE — like any company — will continue to keep raising dividends, especially as military spending tends to be fairly lumpy. But I’d rather see a stellar track record than none at all.
Another encouraging sign is that the payout ratio — the proportion of profits handed to investors — stands at just 46%. Taking this and the sizeable growth seen in the company’s order book as a result of conflict in Ukraine into account, I believe there’s plenty of room left for dividends to grow.
BAE’s forecast dividend yield of 2.5% isn’t particularly big. Then again, I’d rather take that over a company promising more and failing to deliver.
Habitual buy
Consumer goods behemoth Unilever (LSE: ULVR) also interests me.
Yes, I know: boring old Unilever. Who wants to own a stock like this when you have Nvidia multi-bagging in value across the pond?
Well, I do if passive income is the name of the game. Thanks to people buying its low-ticket items out of habit, the Marmite-maker has a solid history of returning cash to its owners. It’s also scored consistently well on ‘quality’ characteristics such as high operating margins and returns on capital.
Perhaps the main thing that grabs me most right now, however, is that the stock looks cheap. A forecast price-to-earnings (P/E) ratio of 16 is lower than Unilever’s five-year average of almost 19.
One reason for this is that analysts are nervous about how well sales of branded goods will rebound once the cost-of-living crisis abates.
No one knows for sure. However, previous economic crises have shown that consumers often revert to old behaviours pretty quickly.
For a yield of 4%, I’d be willing to bet that will happen again.
Chunky income
A final stock I’m considering is one I’ve actually owned in my ISA previously: laser-guided equipment manufacturer Somero Enterprises (LSE: SOM).
Interestingly, it has a much higher forecast yield — nearly 6% — than either BAE Systems or Unilever.
Then again, this is the sort of return I’d want for owning its stock. Somero’s small market cap (just over £200m) and the cyclical line of work arguably make it a more risky proposition. As a rule of thumb, smaller stocks tend to be more volatile in price.
This also helps to explain the low forecast P/E of 11, even though this business also possesses the quality hallmarks mentioned earlier.
On the flip side, the balance sheet continues to look very robust. If there is a general wobble in the markets in 2024, I suspect Somero could weather the storm.
