Earning a passive income continues to be one of the most popular investment objectives today. And it’s easy to understand why. After all, who doesn’t love the idea of making money while sleeping.
Best of all, it’s a goal that most investors can start achieving even with relatively small sums. This is especially true in 2024 where so many dividend stocks continue to trade at a discount. With that in mind, here’s one approach to start earning some extra income within an ISA.
Easy dividends?
Dividend growth stocks are companies that not only pay investors for simply holding stock in their portfolios but also increase these payments each year. And as home to many mature enterprises, the UK stock market’s full of them.
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Take Diploma (LSE:DPLM) as an example. The distribution services group has proven essential to a wide range of industries, resulting in impressive performance over the last decade. So much so that even at a price-to-earnings ratio (P/E) just shy of 50, the premium price tag doesn’t look too outrageous, providing it can maintain its momentum.
But most importantly, the firm’s underlying cash-generating capabilities have enabled it to consistently hike dividend payments for decades. That certainly sounds like a sustainable source of passive income. So with £10k in an ISA, how much money can investors make?
Calculating income
If investors were to snap up shares today, the level of income straight out of the gate would be a little lacklustre. As previously mentioned, this business is trading at a high multiple, resulting in a mediocre yield of just 1.33%. In terms of money, that’s just £133 a year off a £10k investment. And it’s almost a third of what investing in a FTSE 100 index fund can generate at the moment.
However, while the income stream today seems weak, the story looks very different 20 years from now. Over the last 15 years, Diploma has hiked dividends by an average of 14.5% each year. Assuming the firm can maintain this pace, today’s 1.33% yield could grow to 20% by 2044, or £2,000 compared to the initial £133.
That’s a 20% annual investment return from dividends alone, almost three times what the FTSE 100 usually delivers each year, including capital gains!
What about the risks?
Earning Buffett-like returns in the long run is obviously a dream. After all, earning close to 20% each year is how he became a billionaire investor, with the bulk emerging after turning 50 years old. However, it’s important to keep expectations in check.
Just because Diploma has delivered double-digit dividend growth in the past doesn’t mean it will continue to do so. The company’s closing on a £6bn market capitalisation. And while there’s plenty of room left to grow in its target markets, growth always eventually slows.
Therefore, investors may end up earning a passive income that’s smaller than expected. Nevertheless, given the potential reward, it may be a risk worth taking. And Diploma isn’t the only dividend-growth opportunity out there, opening the door to some diversification options that can help mitigate some of the investment risks.
