There is growing nervousness among some investors right now. Many tech shares have seen heavy price falls lately, while some defensive sectors have seen share prices rally. Some people fear that suggests we could see a stock market crash. A crash can be bad for many people — but not everyone. In fact, from a passive income perspective, I think any crash could present me with attractive opportunities.
What a stock market crash means for dividend yields
That is because in a crash, share prices tumble. But if a company does not cut its dividend, a falling share price can mean an increasing dividend yield for those buying at the lower price.
As an example, imagine a company that pays a dividend per share of 5p. If its shares trade at £1, that means that the dividend yield is 5%. So I can hopefully expect money equivalent to 5% of my investment to be paid to me as dividends in the coming year. For example, if I invest £1,000, I would hopefully get £50 of dividends.
But if the share price falls to 80p, the 5p per share dividend would now make for a yield of 6.25%. So if I put £1,000 into the shares at that price, I would be hoping for dividend income of £62.50 in the coming year. Simply by buying the shares after they have fallen in price instead of before, I will have boosted my passive income prospects.
Crashes bring risks
But things might not be that simple in reality. Dividends are never guaranteed. A stock market crash can sometimes be caused by a declining economic outlook. So it may be that as a company share price falls, its earnings also fall. It may be forced to slash its dividend. In that situation, the high yield I initially expect after buying a share could fall once the dividend is cut. In this situation, what looks at first like a bargain passive income stream turns out to be a value trap.
That is why I would look for shares with earnings streams I felt were resilient. That can be difficult to do. A stock market crash caused by the economic outlook worsening could also mean weakened demand. That could hurt companies’ revenues. If the crash is caused by worries about inflation, soaring costs could eat into firms’ profits. So I would want to understand the key cause of a crash when choosing businesses I hoped would remain resilient throughout it.
Passive income ideas I’d consider in a market downturn
Tobacco companies like Imperial Brands tend to not see big falls in demand in a worsening economy. They do face other demand risks, such as falling cigarette customer numbers because of health concerns. That could hurt revenues and profits. For now, strong cash flows at Imperial support a yield of over 7%. If a crash leads to its share price falling, the yield could be even more attractive for my portfolio.
Like Imperial, Direct Line yields over 7%. A financial downturn could lead to customers buying fewer financial products, hurting revenues. Then again, products like car insurance see resilient demand. Pricing increases could offset added costs caused by inflation. That could help sustain the dividend. If Direct Line falls in a stock market crash, it could become a higher-yielding passive income idea I would consider for my portfolio.
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Christopher Ruane owns shares in Imperial Brands. The Motley Fool UK has recommended Imperial Brands. 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.
