The idea of passive income sounds attractive: money one receives without working for it. But while the idea sounds great, the challenge can be putting it into practice. Instead of trying methods like dropshipping, I prefer a work-free income stream which is easy to understand and doesn’t eat into my time. That’s why for passive income I would buy shares using a Stocks and Shares ISA.
Making passive income generation a habit
Even without any money to start, an easy way to begin earning passive income is to build up capital. Even a small amount is better than none. That’s why I would make a habit of saving a set amount monthly, weekly, or even daily. Just a couple of pounds each day can soon add up.
I would start putting the money into a Stocks and Shares ISA. With a small amount of capital to begin, capital preservation would help my income generation potential. So I would choose a low cost ISA. I would also start to look for shares that seem to have a stable long-term future. Instead of plunging into highly speculative new companies, I would focus on companies with stable, reliable, long-term earnings and cash flows. For example, names like Unilever, Diageo,and British American Tobacco would be on my list to investigate in more detail.
Some high yield shares can carry more risk
Some shares offer high yields, but those yields could signal that the market is pricing in some risk of a dividend cut to the shares.
For example, while Imperial Brands continues to offer a high yield, it cut its dividend last year. One reason its yield continues to be high even after the cut is because some investors are pricing in the possibility of another reduction. Telecoms company Vodafone has an attractive yield, but it also cut its dividend a couple of years ago.
So for passive income I would focus exclusively on companies with a long history of raising dividends. Additionally I would look at their free cash flow. Free cash flow is basically how much hard cash a company brings in after it has paid for the running costs and capital needs of its business. That matters because to pay out a dividend year after year, a company will need free cash flow. So, for example, a company with high capital expenditure costs for a new development may not generate enough free cash flow to pay out dividends at its historical level.
A passive income share I’d keep buying
On that basis, one of my favourite picks for passive income would be British American Tobacco. At its current share price, this tobacco giant offers a yield of over 7%. The company has not cut its dividend in over 20 years. In fact, the payout has been increased each year over the past two decades.
Tobacco is a highly cash generative business. Even though western markets are in decline, the company has been increasing total sales in recent years. BAT has also increased its total profits.
That makes it the sort of high yielding share with long-term prospects I find agreeable as a passive income stock. Instead of spending time trying to get into dropshipping or other such schemes to generate income, I would simply start buying BAT shares today.
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christopherruane owns shares of British American Tobacco and Imperial Brands. The Motley Fool UK has recommended Diageo, Imperial Brands, 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.
Motley Fool UK 2021