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Three types of passive income ideas compared

Christopher Ruane
·3-min read
Hand holding pound notes
Hand holding pound notes

Passive income ideas come in all shapes and sizes. Some involve a lot of work – researching a market, setting up a business, and hoping that customers start to buy. I prefer the much easier option of tucking away whatever I can afford each month in a Stocks and Shares ISA, choosing some investments, and then waiting for the income to flow in.

Even so, not all shares chosen as passive income ideas have the same characteristics. Here I explain three types of passive income ideas and which I prefer.

Slow and steady

A typical passive income choice would be a large company in a long-established industry with a history of payouts. The advantage of such a choice is that such companies’ revenues and profits tend to be fairly stable. With long experience in an industry, it should be well-entrenched and have the know-how to ride out changes in its marketplace.

The downside of this type of passive income choice is that stable, well-run companies with a history of payouts for many years are often appreciated by lots of investors. That can drive their share prices up. That matters for passive income because a share’s yield is based on its share price. Even if it pays a big dividend, if the share price is high, the yield may be just average.

An example of this kind of share is Unilever. While I think the consumer goods giant has solid long-term prospects, its yield of just over 3% is not that exciting to me. It would certainly produce some passive income, but not as much as I’d like.

Slow and steady but unfashionable passive income ideas

Applying the same principles, there is a group of industries whose characteristics look similar but which are nonetheless out of fashion. Tobacco and oil are examples. While there is debate about how long demand will last, some tobacco companies have a long history in a highly cash flow generative industry. But between worries about the long-term future of demand and the ethics of selling tobacco, the shares currently offer high yields.

For example, British American Tobacco is yielding over 7%. BAT has raised dividends annually for two decades. So for passive income ideas, these are the sorts of shares I prefer to pick. Indeed, I have both BAT and Imperial in my own portfolio.

High-yielding but cyclical

A third type of passive income share pick is companies that currently offer a high yield but that are in cyclical industries. Cyclical industries are ones where demand can go up and down every few years, affecting prices. Sectors such as energy extraction, raw materials, and mining tend to be cyclical.

So, for example, Evraz currently has a double-digit dividend yield. That sounds attractive among passive income ideas. But my concern is about whether it can be sustained. The mining company is in an industry known for being cyclical. So while its current yield looks mouth-watering to me, I don’t see it as stable for the future. That makes it less attractive to me as a passive income choice.

The post Three types of passive income ideas compared appeared first on The Motley Fool UK.

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christopherruane owns shares of British American Tobacco and Imperial Brands. The Motley Fool UK has recommended 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