£9,000 in savings? Here’s how I’d aim to turn that into £684 a month in passive income!

Money put in high-dividend-paying stocks with the returns used to buy more shares can transform small investments into big passive income over time.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

A pastel colored growing graph with rising rocket.

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Passive income is money made with little effort, so it sounds too good to be true to some. Certainly, many of the methods claiming to generate such income look far from passive to me.

However, investing in shares that pay dividends is one way that has consistently fitted the bill in my experience.

Aside from selecting the shares and monitoring their progress occasionally, nothing much else needs to be done.

Selecting the shares

British American Tobacco (LSE: BATS) is a good example of a great passive income stock, in my view.

First, it provides a very high annual yield that in turn generates a very high passive income. Specifically, it paid a total dividend of 230.89p in 2023, yielding 8.1% on the current share price of £28.36.

Second, a discounted cash flow analysis shows British American Tobacco to be 57% undervalued at its present price. So, a fair value for the stock would be £65.95, although it may go lower or higher than that.

In my experience, this underpricing decreases the chance of the passive income being wiped out by sustained share price losses. Conversely, it increases the likelihood of a share price rise over time, adding to the overall earnings from the stock.

Third, it has very strong earnings prospects. These are what drive a firm’s dividends (and share price) higher over time. Analysts forecast that British American Tobacco’s earnings will increase by a stunning 46.5% every year to the end of 2026.

They also expect its dividend yield to rise to 8.3%, 8.7%, and 9% in 2024, 2025, and 2026, respectively.

How much passive income can be made?

All firms have risks attached to them, of course, and this one is no different. A main risk for British American Tobacco is that its ongoing shift to nicotine substitute products will stall for some reason.

However, as it stands, £9,000 – the same amount I had when I started investing 30 years ago – can generate big dividends over time.

At the current 8.1% yield, this would generate £729 in dividends in the first year. Over 10 years on the same average yield it would be £7,290, and after 30 years, £21,870.

That said, much more could be made by buying more British American Tobacco shares using the dividends rather than spending the money.

The power of dividend compounding

Doing this (‘dividend compounding’) would make an extra £11,176 rather than £7,290, given the same average yield. Over 30 years on the same basis, an additional £92,399 would be generated, not £21,870.

With the initial £9,000 added, this would pay £8,213 a year in passive income, or £684 a month!

Assuming inflation over the period, the buying power of the money would be somewhat reduced by that time. There would also be some tax to pay, according to individual circumstances.

However, this clearly shows the size of annual passive income that can be made over time from much smaller investments. This is even more the case if those dividends are regularly used to buy more of the stock that paid them.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Simon Watkins has positions in British American Tobacco P.l.c. The Motley Fool UK has recommended British American Tobacco P.l.c. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

US Stock

The Nvidia share price falls! Here’s what I think happens next for the S&P 500

Jon Smith reviews the overnight results from Nvidia and explains why this could stall the S&P 500 performance through to…

Read more »

Investing Articles

Down 15% today, is this FTSE 100 share too cheap for me to miss?

JD Sports' share price has tanked after the FTSE 100 share released another profit warning. Is this the opportunity I've…

Read more »

Investing Articles

Up 8% today, is this FTSE 100 growth stock a slam-dunk buy for me?

Halma's share price is soaring thanks to another headline-grabbing trading update. Is the FTSE 100 stock now too good for…

Read more »

Investing Articles

With a P/E ratio of just 10.5 is now a brilliant time to buy a cut-price FTSE 250 tracker?

Harvey Jones says a recent dip in the FTSE 250 leaves the index trading at bargain levels. One stock in…

Read more »

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

To build a passive income flow, I’d follow this Warren Buffett approach

Warren Buffett has set up passive income streams most people can only dream about. Our writer sees some practical lessons…

Read more »

Growth Shares

As the boohoo share price falls, could it become a penny stock in 2025?

Jon Smith outlines some of the recent problems involving the boohoo share price and considers if things could get even…

Read more »

Young Asian woman with head in hands at her desk
Investing Articles

Here are the worst-performing FTSE 100 shares over the last 5 years

These five FTSE 100 shares have been complete duds over the last half decade. But is there potential for a…

Read more »

Investing Articles

Nvidia stock has tripled this year! Can it keep rising?

Nvidia's latest sales update showed strong growth and the stock's been on a tear so far in 2024. So is…

Read more »