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I think of passive income as money made while I sleep. Perhaps I got the idea from legendary investor Warren Buffett, who said: “If you don’t find a way to make money while you sleep, you will work until you die.”
Anyhow, the best way I have found of making money with little effort is through dividends paid by shares. The higher the better, of course, and the longer they persist even better than that.
Recently I added to my portfolio of such shares, based on three key factors — so what were they?
7%+ annual dividend yield
First, the stock – investment management giant Man Group (LSE: EMG) – has a projected yield of over 7%.
This figure is important to me, as it reflects compensation for the extra risk in investing in shares over no risk at all. And the current ‘risk-free rate’ (10-year UK government bond yield) is 4.6%.
Man Group’s current dividend yield has drifted below this level – to 6.5% — given a surge in share price recently. However, analysts forecast it will rise again this year to 7%, next year to 7.1%, and in 2027 to 7.6%.
This also compares very favourably to the present FTSE 250 average dividend yield of 3.5%. The FTSE 100’s is even lower – at just 3.1%.
So, Man Group passes this test for me.
Undervalued share price
I never sell my passive income stocks if they continue to perform as I think they should. However, if they do not, I would obviously prefer to make a profit if I do sell.
The chances of this happening are greatly improved in my experience if the stock is undervalued when I buy it. This means that there should be as big a gap as possible between its price and its ‘fair value’.
I have found over the years that the discounted cash flow method is the best way of pinpointing this difference.
In Man Group’s case, it shows the stock is 44% undervalued at its current £2.01 price. Therefore, its fair value is £3.59.
Second test also passed.
Strong earnings growth
Handily for me, both the dividend and share price trajectories of any stock tend to be driven by one thing – earnings growth.
Risks to Man Group’s is a sudden change in global liquidity, interest rates, and/or geopolitical events. These can trigger rapid outflows in assets under margin and compress profit margins.
However, its 17 October Q3 trading statement showed a 22% year-on-year rise in assets under management to a record $213.9bn (£159.7bn).
Moreover, analysts forecast that its earnings will grow by a whopping 36% a year to end-2027.
Third test passed.
My investment view
Another £10,000 investment in the stock by me would generate £11,332 in dividends after 10 years. This is based on reinvesting the dividends back into the stock and a 7.6% average yield.
After 30 years on the same basis, this would rise to £87,066. Including the £10,000 investment, the total value would be £97,066.
And this would deliver a total annual passive income of £7,377.
Given it passed all three tests, I will be adding to my holding in the stock very soon.
I am also looking at several other high-yield shares that have caught my attention recently.
