One of my favourite ways to earn passive income is with dividends. That’s because once individual shares have been bought, I find that it’s a relatively low-maintenance option.
With dozens of potential options in the FTSE 100, I try to narrow down the selection using a short checklist.
The checklist
For reliable passive income, I’m looking for reliable dividends. That means consistent payouts, which means back-to-back dividend payments every year for many years. More specifically, I look for a dividend history of at least five years. That said, many Footsie shares have consistent payments spanning decades.
Next, I want my income to be affordable to the companies that I invest in. Dividends are typically paid from earnings. So I look if they’re earning enough to cover payouts. This measure is known as dividend cover. More specifically, I look for a cover greater than 1.5.
Last but not least, I look for a dividend yield between 2% and 8%. There are some FTSE 100 shares that offer more than 8% but very high yields aren’t always sustainable, so I’d avoid those.
Top shares for passive income
Some shares that I’d buy for this plan that meet all my criteria include Imperial Brands (7.5% yield), Rio Tinto (6% yield), and Sainsbury (5% yield).
One point to note though. I don’t want to restrict my list to high-dividend payers. Although they would provide me with the largest passive income in the near term, those offering lower dividend yields might end up being long-term winners.
Seeing beyond the yield
Allow me to explain. Footsie-listed BAE Systems (LSE:BA.) currently offers a 2.5% dividend yield. That doesn’t look very special at first glance. But note that its annual dividend has tripled over the past 20 years.
BAE investors from back then now enjoy around a juicy 17% dividend on the price they paid. That’s why dividend growth is an important factor to consider.
BAE offers over three decades of back-to-back dividend payments. In addition, 20 of those years have seen consistent dividend growth.
With a dividend cover of 2.1, I’d say its earnings more than comfortably cover its payouts.
Mega trends
Global spending on defence rose by 7% from 2022 to 2023 and it’s widely expected to continue its upward trajectory amid war and political tensions.
Cybersecurity is also likely to be a key risk to organisations and governments over the coming years. To prevent cyber-attacks, spending in this area is also likely to rise.
BAE is a pioneer in developing new technologies across aerospace, defence, and cyber-security. I reckon it’s well-positioned to capitalise on these trends.
Bear in mind that changing governments can lead to shifts in policy regarding defence. It’s something that I’d keep an eye on globally.
Targeting regular income
To target £350 of passive income every month, I calculate I’d need to invest between £50,000 and £85,000. That’s based on a dividend yield between 5% and 8%.
If I don’t have these sums to invest, I’d make a start by saving and investing every month to build the pot. I’d also reinvest the dividends to speed up the time it takes.
