Building a successful passive income can be life changing. It means breaking the link between the time you spend working and the income you receive. In my view, dividend stocks are one of the best ways to generate a passive income. But it’s not always easy.
Achieving a reliable passive income means finding businesses that can generate steady growth over many years, while generating plenty of cash for dividends. Not all popular dividend stocks fit this description. For example, the big FTSE 100 miners are paying big dividends now, but they all slashed their payouts five years ago, when commodity prices crashed.
The three companies I’m going to look at today are all shares I own in my portfolio. All three have long histories of dividend growth and strong financial metrics. I reckon they’re among the best passive income ideas in today’s market.
I’ve snapped up this 6.6% yield
I recently added more Legal & General Group (LSE: LGEN) shares to my ISA portfolio. This FTSE 100 financial giant is one of the safest high-yield stocks on the market, in my view.
Legal & General’s business model involves investing huge amounts of cash in long-term assets, including stocks, renewable energy assets, commercial property, and rental housing. At the end of June, L&G had £1.3trn of assets under management.
The income from these operations is then used to support the group’s life insurance and pensions businesses. A generous slice of surplus cash is returned to shareholders each year and the dividend has doubled since 2013.
Indeed, except for a cut during the 2008 financial crisis, Legal & General’s dividend has grown continuously for more than 30 years.
Of course, a long dividend history does not guarantee that dividend payments will continue to rise in the future. But I think it’s strong evidence that this business is run with a focus on cash generation and shareholder returns. I reckon that’s a good start for a passive income stock.
Quality passive income
There are other insurance companies out there with attractive dividend yields. So why have I chosen Legal & General?
After following this business and other similar stocks for many years, I’ve noticed that L&G’s business model is consistently more profitable than UK rivals such as Aviva. I also like Legal & General’s clear and focused financial reporting, which emphasises information that’s important to me, such as cash generation and return on equity.
The main risk I can see is that Legal & General’s operations could become so large, complex, and hard to manage that — at some point — returns will fall below expectations. A situation like this could take years to put right, during which shareholders might see their dividends (and shares) fall.
Personally, I’m willing to accept this risk. Legal & General shares currently trade on eight times forecast earnings, with a 6.6% dividend yield. I’ve been buying at this level and believe this passive income stock looks too cheap.
We are all customers
Find me a household in the UK — or most other countries — which doesn’t have any Unilever (LSE: ULVR) products in it. I know my home has several. I’m pretty sure that yours probably does too.
As consumers, many of us are very loyal to our favourite brands, especially when they are frequent, low-cost purchases. The beauty of Unilever’s portfolio of branded consumer products is that they are regular, repeat buys.
Someone who prefers Persil washing powder, Ben & Jerry’s ice cream, or Hellmann’s mayonnaise probably doesn’t consider many alternatives. Unilever has 400 brands in 190 countries and its products are used daily by 2.5bn people. That’s the beauty of the group’s business model — billions of small, regular brand interactions.
The challenge for the group is that it must keep pace with changing consumer tastes, as well as more difficult issues like sustainability. As a heavy user of palm oil and plastics, for example, Unilever isn’t beyond criticism.
Another risk is that the prevalence of cheaper, own-branded products in supermarkets will gradually erode Unilever’s advantages. We all know that some of these own-brand items are just as good as the branded alternatives.
So far, Unilever has managed to stay ahead of the game. The group’s history stretches back 150 years and its dividend has not been cut for more than 50 years. Although the stock’s dividend yield is pretty average, at 3.7%, Unilever’s consistent high profit margins and steady growth mean that I think this is one of the safest dividends in the FTSE 100.
An overlooked passive income stock
Virtually all modern products and services must be certified in some way. They must do certain things and not do other things. If they’re misused, they must still be safe. And they must always be the same, however many are produced.
Who checks all of this and makes sure it happens? One of the leading players in the quality assurance and certification sector is FTSE 100 firm Intertek Group (LSE: ITRK). Intertek provides assurance, testing, inspection, and certification services to industries including aviation, chemicals, consumer goods, food, and transportation.
The group’s history goes back 130 years, but it came into existence in its current form in 2000, when it joined the FTSE 250. Back then, the shares traded at £4. Today, they change hands for over £50.
Intertek’s dividend has followed a similar upwards path. Payouts started at 8.1p per share in 2003. The dividend has never been cut and today stands at 106p per share.
Intertek isn’t as well-known as some the other two companies I’ve looked at today. But I think it ticks all the boxes for a high-quality passive income stock.
What could go wrong? One risk is that the main risk is that Intertek could fall behind rivals in offering new services, causing growth to slow. A second concern is that the group could start to overpay for acquisitions, reducing future returns.
So far, Intertek has avoided these problems. The group’s operating margin has averaged a healthy 15% in recent years. Profits are expected to bounce back in 2021, after the challenges of last year.
Although Intertek shares trade on 28 times forecast earnings and offer a modest 2% dividend yield, I think this is an excellent passive income stock. I’ve recently been buying the shares and intend to hold them for many years.
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Roland Head owns shares of Intertek, Legal & General Group, and Unilever. The Motley Fool UK has recommended Intertek and Unilever. 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.