Shares in Burberry (LSE:BRBY) aren’t quite at a 52-week low – but they’re pretty close. Yet I think an £8,000 investment in the UK fashion house’s shares could eventually return £1,000 a year in passive income.
Compounding an initial outlay of £8,000 at 5% for 20 years results in an investment that generates £1,010. And I think that’s the best way to aim for passive income over the long term.
Burberry
The investment case for Burberry shares is reasonably straightforward. The entire business currently has a market-cap of £4.5bn – and that looks cheap when I see the firm’s projections.
In the medium term, the company is aiming for £4bn in revenues and an operating margin of around 20%. So that implies a price-to-operating-earnings ratio of five.
By anyone’s standards, that’s not expensive. And at least 80% of Burberry’s operating income typically becomes free cash flow, implying a 16% return over the medium term.
So the thesis is simple. If the business achieves anything like its medium-term targets, the stock looks like a bargain – and there’s a dividend with a 5% yield in the meantime.
Risk
The big risk for Burberry is that 22% of its sales come from China. I don’t think there’s a big political issue here – in the style of Apple with its iPhones – but I think there’s an economic danger.
If the Chinese economy stays subdued for an extended period, then it might take a while for Burberry to achieve the targets it has set out. And that might make for a disappointing investment.
Despite this, I don’t see an immediate threat to the company’s dividend. In 2023, it generated almost £1.22 in earnings per share and paid out 61p per share to shareholders.
If that 5% dividend proves to be durable, then I might well make enough to turn £8,000 in cash into £1,000 a year in passive income. And the share price staying down might be a good thing.
Compounding
An important part of the plan is being able to compound my dividends at an average annual return of 5%. If the Burberry share price increases faster than its dividends, I might not be able to do this.
In that situation, I’d have to look elsewhere to find a 5% dividend yield. That’s probably not impossible, but it would be easier to just reinvest it back into the company.
I’d therefore be very happy if Burberry just pushed along steadily and kept increasing its dividend gradually. I don’t need the company to be in a hurry to reach its £4bn sales target.
At today’s prices, £8,000 could buy me 630 shares in Burberry. And I think that would be a fine way to start a passive income portfolio.
One last thing…
Recently, a number of UK companies have found themselves the target of acquisitions. I’m not saying this is likely to happen with Burberry, but I wouldn’t rule it out.
If that happens, I might have to swap a long-term passive income investment for a short-term payout. That’s not part of my investment thesis, but there are worse things that could happen.
This post was originally published on Motley Fool
