Here’s how I’m targeting £17,497 in annual passive income from my £20,000 in this top-flight passive income gem
Perhaps the best way of thinking about passive income (money made with little effort) came from legendary investor Warren Buffett.
He said: âIf you donât find a way to make money while you sleep, you will work until you die.â
I have found the best way to make money while I sleep is by investing in high-dividend-paying shares.
The earlier this process is begun, the better, as it allows income to grow through âdividend compoundingâ. Much like leaving savings to accrue in a bank account, this compounding effect can quietly turbocharge long-term returns.
So, what do I think the best passive income stock in my portfolio is right now?
What I want in a passive income stock
FTSE 100 financial giant Legal & General (LSE: LGEN) has the three key qualities I want in such a stock.
First, it offers a market-beating ultra-high dividend yield of 8%, more than double the FTSE 100âs 3.1% current average. More positively still, analysts forecast this will rise to 8.5% this year, 8.7% next year, and to a stunning 9% in 2028. This means the turbocharging of my dividend income will begin from an already very high base.
Second, the shares look to be extremely undervalued — 57%, in fact, using my own discounted cash flow modelling. Some analystsâ modelling is more conservative, but based on a 7.1% discount rate of projected future cash flows, my DCF modelling suggests a âfair valueâ of £6.21.
The present price is £2.67, and stock prices can trade toward their fair value over time. Consequently, this valuation gap reduces the chances of my losing money if I sell the share. Conversely, of course, it increases the possibility that I make money in that event. Not that any of this is guaranteed.
And third, I want an underlying business forecast to deliver strong earnings (âprofitsâ) growth. It is this that ultimately drives both share prices and dividends higher. In Legal & Generalâs case, analysts forecast average annual earnings growth of a whopping 21.2% to end-2028.
How much can I make?
A risk to the stockâs ongoing ultra-high returns is the intense competition in its sector, which may pressure its margins.
Even so, based on the current 8% yield, my £20,000 Legal & General holding could generate £24,393 in dividends after 10 years. This ignores any forecast rises in the yield, and the possibility of a decline over time, which can occur. It also assumes the dividends are reinvested back into the stock to harness the power of dividend compounding.
On the same basis, the dividends would rise to £198,715 after 30 years, although there is no certainty that this will happen. Including my original £20,000 investment, the holding could be worth £218,715 by then.
And that could give me a yearly passive income from dividends of £17,497!
My investment view
Legal & General ticks all three boxes I look for in a passiveâincome stock: a huge yield, clear undervaluation, and strong forecast earnings growth.
On that basis, I plan to buy more shares to strengthen my long-term income stream.
I also believe the combination of high income, attractive pricing, and solid growth prospects makes the stock well worth the consideration of other investors too.
The post Hereâs how Iâm targeting £17,497 in annual passive income from my £20,000 in this top-flight passive income gem appeared first on The Motley Fool UK.
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Simon Watkins has positions in Legal & General Group Plc. The Motley Fool UK has no position in any of the shares mentioned. 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.
