Earning passive income is an important objective in my investing. A lot of the shares I consider buying are attractive to me at least in part for their income potential. That is one of the reasons I have occasionally been eyeing pharmaceutical firm GlaxoSmithKline (LSE: GSK) for my portfolio over the past couple of years. But the GlaxoSmithKline dividend, offering a yield of 5.1%, is not quite as appealing to me as it initially seems. Here is what makes me nervous – and has held me back from adding the company to my portfolio.

Lack of dividend growth

A company’s dividend history is not necessarily indicative of what it will do in future. But it can help me understand how a company has been thinking about its dividend. At surface level, the 5%+ dividend on offer at GlaxoSmithKline would be an attractive addition to my portfolio. It is higher than the dividend yield offered by many other blue chip companies.

However, the dividend has been flat for years. The last increase was in 2014. Although the 80p per share dividend remains generous, what concerns me is why the company has repeatedly decided not to raise its dividend. I feel it suggests that the business has not been improving enough to make the board feel comfortable with spending more money on a dividend.

Plan for the GlaxoSmithKline dividend to fall

The lack of confidence to grow the dividend is not what most concerns me here. It is what comes next.

GlaxoSmithKline is routinely described as a pharmaceutical business. But it also has a large consumer goods business selling non-prescription items often found in chemists. These include household names such as toothpaste Aquafresh and painkiller Panadol. It is easy to understand how those two businesses developed in tandem. GlaxoSmithKline now plans to spin off its consumer goods business into a different company. It hopes to unlock more shareholder value by letting the two businesses sharpen their focus in their own particular areas.

But this is set to be bad news for dividends, at least in the short term. The company has said that the pharma business expects to pay 45p per share in dividends next year. The dividend for the consumer goods business will depend on its directors. But it is expected to come in at around 7p per share. That would mean a total annual dividend of 52p per current share, compared to 80p now. So, if I bought GlaxoSmithKline shares for my portfolio today, although the current yield is 5.1%, the prospective yield for next year is a much less attractive 3.3%.

I will not buy GlaxoSmithKline for yield

So, after years of a flat dividend, GlaxoSmithKline is likely to see a big dividend cut next year. A reorganisation meant to unlock shareholder value will in fact probably result in lower shareholder distributions, at least in the beginning.

I think that shows a lack of determined focus on the part of the company’s management when it comes to maintaining or growing shareholder returns. That concerns me, because it makes me wonder if increasing the dividend will be a priority in future. With the yield set to fall and a questionable focus on the importance of dividends to shareholders, I do not plan to add GlaxoSmithKline to my portfolio.

Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended GlaxoSmithKline. 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.

Dividend investment has always been a reliable method of building passive income streams. Now, as UK inflation reaches an alarming high of 5.4%, I am more determined than ever to find a long-term dividend stock to keep my portfolio stable during such tough times.   

The share price of tobacco company Imperial Brands (LSE: IMB) has steadily risen to 1,757p, up 7% since the start of the year. The company is clearly recovering from its 15-year low in November 2020, at 1,219p. A look at its FY21 results suggests a reported 15% increase in operating profit and continued dedication to the company’s five-year plan has reinvigorated investor confidence. Imperial has an impressive 8% dividend yield and growing financial performance. I am certainly considering this tobacco giant as a long-term addition to my portfolio. 

Dividend coverage

While such a high yield is enticing, a look at Imperial Brands’ coverage raises some concerns. Dividend coverage is calculated by dividing the company’s net income by the dividend paid to shareholders. It is an indication of how much risk a company is taking in paying its dividends. 

The company’s dividend coverage decreased from 1.85 in FY20 to 1.78 in FY21. While this may not seem like a large drop, it is certainly distressing. Imperial Brands’ net income is less than twice as much as its dividend payout. This means a considerable reduction in yield could be necessary in order to protect overall financial health. The stability of its dividend yield may be at notable risk. 

Compare this to Persimmon (LSE: PSN), which currently holds an impressively high dividend yield of 9.7%. A look at the company’s half-year results for FY21 shows a return of £750m to shareholders, which included top-up payments delivered in respect of previous dividend fluctuations. The company’s commitment to its dividends is supported by a consistent total equity of over £3bn throughout FY18-20. Imperial Brands is yet to deliver such persistent commitment to its payouts. Yet as the company begins to stabilise its financial health, it could potentially reach a strong level of consistency.

A stable financial performance 

Despite coverage concerns, improvements in financial performance suggests Imperial Brands is prepared to deliver steady dividends in coming years.

Long-term increases in total revenue, from £27.6bn in FY16 to £32.5bn in FY20, show consistent financial growth. A more recent rise in operating profits, from £2.7bn in FY20 to £3.1bn in FY21, has also expanded opportunities for the company’s free cash flow. Indeed, with such cash flow set “to drive investment and shareholder returns”, my confidence in the tobacco giant’s ability to provide persistent dividends increases.

A 25% decrease in dividend payments from FY20-21 may be concerning. However, it is clear this reallocation of funds to debt reduction has been a successful managerial decision. The company has reduced its adjusted net debt by £1.7bn. This has created a far more stable position as it looks to meet its commitment to its five-year plan.

The tobacco company has achieved enormous success stabilising its overall financial position. With an 8% dividend yield now well-supported, and currently beating UK inflation rates, I will be looking to add Imperial Brand shares to my portfolio.

Hamish Cassidy has no position in any of the shares mentioned. 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.

Key points

• 2022 fiscal year interim revenue was over 20 times higher than one year previously
• The company was recently awarded a £9.4m grant by Green Hydrogen for Scotland
• In February 2022, Credit Suisse slashed its target price from 340p to 235p  

Having fallen 56% since this time last year, the ITM Power (LSE: ITM) share price has obviously disappointed current shareholders. Nonetheless, by developing electrolysers to safely extract hydrogen from water, the company has become a big-hitter in the green energy market. Attracting the attention of many governments, the firm has recently seen rising revenue and narrowing losses. But I want to know if the business is really a shrewd investment for my portfolio. Let’s take a closer look.  

Optimism for the ITM share price

There have been a number of recent exciting updates involving the company. In January 2022, the firm sold a 24 megawatt (MW) electrolyser to Norwegian business Linde Engineering. This should begin to generate revenue in the 2023 fiscal year.

In the same month, the German education ministry awarded ITM €1.95m in funding for the development of hydrogen power. This is part of a wider move by Germany to increase the amount of energy produced involving hydrogen. Furthermore, the Green Hydrogen for Scotland initiative awarded the company £9.4m in November 2021. It also appears Scotland is keen on exploring the possibility of hydrogen power.

In sum, the ITM share price could benefit from further moves by countries to move to greener forms of energy. The financial services firm Jefferies recently increased its ITM share price target to 800p, owing to the company’s activity in this sector. 

Recent results

In a recent trading update for the six months to 31 October 2021, the firm reported a £250m fund raise. This will finance the construction of a second UK factory in Sheffield and its first overseas operation. 

In spite of this expansion, Credit Suisse slashed its target ITM share price from 340p to just 235p. This was primarily because it thought the move to greener energy “might favour alkaline and solid oxide technologies”. Such a fall in the price target is concerning, chiefly because Credit Suisse believes the future of hydrogen energy may not be terribly bright.  

In spite of this, however, recent results appear to be going in the right direction. For the period, ITM’s revenue grew to £4.1m. This is a vast improvement from the same period in 2020, when revenue was only £200,000. Furthermore, losses started to narrow to £2.4m from £2.8m in the same period in 2020. 

There is some excitement in the ITM share price, inspired by recent deals with governments. While revenue is improving, it is still minuscule in comparison to the firm’s market capitalisation of £1.4bn. For now, I think I’ll avoid buying shares in this company. But I will leave open the possibility of purchasing at some point in the future if results continue to improve.  

Andrew Woods has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

I keep a close eye on Lloyds Banking Group (LSE: LLOY) as a bellwether (guide) to the state of the UK economy. Lloyds has a huge UK presence — and not just from its branches on our high streets. The FTSE 100 bank has around 65,000 employees serving roughly 30m customers. It is the UK’s largest mortgage lender, with more than a fifth of existing home loans. It’s also a leading provider of credit to British businesses and individuals. That’s why I check the Lloyds share price most days, even though I don’t own this share — yet.

The Lloyds share price plunge

From early 2017 to late 2019 — almost three years — the Lloyds share price pretty much went sideways. On 13 December 2019, it closed at 64.33p, down 7.1% since 24 February 2017 (five years ago). But as Covid-19 went global in early 2020, Lloyds shares crashed along with the wider market. Almost unbelievably, the share price crashed to a rock-bottom low of 23.58p on 22 September 2020. The next day, I said Lloyds shares offered a lifetime of value.

Lloyds bounces back

As I write, the Lloyds share price hovers around 50.83p, valuing the group at £36.1bn. That’s almost double the market cap seen at September 2020’s low. Here’s how the shares have performed over five time periods: Five days: -0.8% | One month: -1.7% | Six months: +15.7% | One year: +32.4% | Five years: -26.6%. Thus, Lloyds has been a great buy since 2020, but a loser since 2017.

For the record, I haven’t owned Lloyds shares since the early stages of the global financial crisis of 2007-09. Back then, bank and financial stocks dominated my portfolio. But I ditched the lot in 2007-08, after growing increasingly anxious about a house-price crash and credit crunch. I’ve hardly bought bank shares since. But I think Lloyds shares might be my first buy in banking in many a year.

I see Lloyds as dirt-cheap today

At the current Lloyds share price, the stock trades on a modest price-to-earnings ratio of 7.8 and an earnings yield of 12.9%. The dividend yield of 2.4% a year is lower than the FTSE 100’s 4% cash yield. But the UK banking regulator ordered banks to cancel their dividends early on in the coronavirus crisis. Hence, Lloyds’ dividend is coming back from a lower base, so I expect it to keep rising.

To me, these are undemanding fundamentals, especially for a large-cap FTSE 100 share. What’s more, four economic tailwinds appear to be in Lloyds’ favour. First, the UK housing market is going great guns, which is good news for mortgage lenders. Second, the Bank of England has raised its base rate twice, with more rate rises pencilled in. Higher interest rates usually mean wider net interest margins (rate spreads) for big lenders such as Lloyds. Third, the UK economy is growing strongly, which might eventually lead to increased business borrowing. Fourth, Lloyds has a strong balance sheet, including billions of pounds of spare capital. Ideally, this cash cushion should be returned to shareholders as higher dividends and share buybacks.

All four of these factors should help to support the future Lloyds share price. However, hardly anything ever goes smoothly over any lengthy period. For example, a resurgence of Covid-19 would throw a big spanner in my expectations. Also, a cooling economy would hit Lloyds’s growth. Even so, I plan to buy ASAP with the Lloyds share price at current levels!

Cliffdarcy has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. 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.

One of my favourite ways to generate passive income is buying and holding dividend shares. If they pay me dividends in future – which is never guaranteed – then I will be able to watch my income pile up without having to lift a finger.

If I decide to target a specific monthly passive income, I can make a plan around that goal. Here is my approach.

Start with the end in sight

To begin, I decide how much passive income I would like to target each month. I find it easier to do this as a monthly average than to target exactly the same amount each month. That is because companies pay out dividends on their own schedules and these are not fixed.

A monthly £200 adds up to £2,400 a year. How much would I need to spend on dividend shares to generate that? That depends on what is known as dividend yield. Yield is basically an expression of a share’s dividends as a percentage of its current purchase price.

To generate £2,400 a year in dividends, if I was investing in shares yielding 10%, I would need to spend £24,000 buying shares. If I bought shares yielding 5%, that would increase to £48,000. If I bought shares yielding 2%, I would need £120,000 to hit my target.

Why I do not look at yield alone

So far, it sounds as if yield is a big deal. Based on that, I could go out and buy shares yielding 10% or even more, such as Evraz and Ferrexpo. But there are a couple of problems with such a purely yield-focussed approach that could cost me dearly.

First, Evraz and Ferrexpo are both miners. To reduce my risk, I would want to diversify my share ownership across different business sectors and companies. So while having some miners in my portfolio would be fine, if I only bought shares in miners then I may well see my passive income drop a lot the next time the mining industry enters a cyclical downturn. That is not just true of mining: I would not want to concentrate my whole portfolio on any single sector, no matter how appealing it looks to me today.

Quality and passive income

Another problem with just buying high-yield shares is that unusually high yields often imply that the City thinks a share has elevated risks. Evraz and Ferrexpo both face considerable political risk, for example.

That does not mean that I avoid high-yield shares altogether. If I want to target passive income, higher-yielding shares can help me do it with less money. But I do not buy shares just because of their high yield. Instead, I focus on companies that I think have had a good chance of maintaining or increasing their dividend. So I consider factors like their business model and future customer demand, the level of cover provided for the dividend by cash flow and also anything that could hurt a company’s future ability to pay dividends, like big debts falling due. If I find a high-quality company with an attractive yield, then I consider it as a candidate for my portfolio to help me reach my passive income goal.

Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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FTSE 100 firm NatWest Group (LSE:NWG) released its 2021 full-year results on Friday (18 February). They were a mixed bag of figures, with the NatWest share price closing down on the day. I don’t own this Footsie share at present, but would I buy at current price levels?

NatWest returns to profit in 2021

Last year, the bank made a net profit of £2.95bn. This was a great improvement on the £753m loss the former Royal Bank of Scotland (RBS) made in 2020. However, this performance was boosted by almost £1.3bn of loan-loss reserves being written back into its bottom line. In the final quarter of 2021, NatWest’s net profit hit £434m, versus a £109m loss in Q4/2020.

Though it benefited from increased activity in the booming UK property market, it took three big hits to earnings. First, costs spiralled from the firm’s decision to withdraw from Ulster Bank in the Republic of Ireland. It lost €300m (£250m) from this ongoing disposal in 2021 and could lose another €600m (£500m) in related costs by end-2024.

Second, NatWest Markets — the bank’s trading division — made a hefty loss in 2021. Often a thorn in its parent’s side, the operation recorded an operating loss of £302m in the fourth quarter and a full-year loss of £711m. This was a substantially worse outcome than the £227m this subsidiary lost in 2020. Third, NatWest was fined almost £265m in December, after being convicted of  anti-money-laundering failures. Yikes.

A cheap FTSE 100 share?

After these results — described as ‘messy’ by one City analyst — NatWest shares lost 5.8p (-2.4%) to close at 234.5p on Friday. This values the group at £26.4bn. This fall came despite news of a final dividend of 7.5p per share — plus a share buyback of £750m from NatWest in the first half of 2022.

One overhang for this stock is that NatWest is still majority-owned by HM Government (HMG). This followed a huge bailout of RBS during the banking crisis of 2008. Currently, the taxpayer owns just over half (51%) of the bank. Of £3.8bn of capital distributed to shareholders last year, £1.7bn went to HMG.

On the plus side, the bank’s Common Equity Tier 1 (CET1) ratio of 15.9% reflects a strong balance sheet. This still leaves the group with perhaps £3bn of excess capital for future distribution.

NatWest shares have risen by 10.2% over six months and leapt by 28.4% over the past 12 months. However, they are down 1.6% over the past five years. Right now, this share trades on a price-to-earnings ratio of 11.6 and an earnings yield of 8.6%. The dividend yield of 2.6% a year is below the FTSE 100’s 4% cash yield.

Although these fundamentals look undemanding to me, I believe I can find better value elsewhere in the FTSE 100. What’s more, with HMG pencilling in more share sales in 2022-23, this could act as a brake on future share-price gains. Right now, I prefer Lloyds Banking Group shares to NatWest today (for Lloyds’ superior earnings yield). In summary, though NatWest looks in decent shape to me today, I won’t buy its shares. Instead, I’ll seek out better value elsewhere in the FTSE 100.

Cliffdarcy has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. 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.

It isn’t enough just to look for stocks with big yields when trying to make a passive income. Some of the largest yields come from companies that are very susceptible to wild profits swings. Such shares can’t be relied upon to generate income-boosting dividends year after year.

Take Russia-focused steelmaker and mining company Evraz (LSE: EVR). This FTSE 100 firm has slumped in recent weeks as Russian troops have gathered on the borders of Ukraine. Fears that production could be disrupted (it also operates mining assets in Ukraine), and may have trouble selling its product if Russia is hit with sanctions, have sent investors running.

Evraz’s sinking share price has in turn sent its dividend yield through the roof. It currently sits at a jaw-dropping 38.2%! This is a warning sign that the City’s dividend forecasts could be looking a tad stretched. Conflict in Europe isn’t the only threat to Evraz’s profits, either. Over the long term earnings and dividends could suffer significantly whenever the global economy slows and revenues dip.

A better FTSE 100 stock for a passive income

I’m not saying that Evraz isn’t worth investing in today. Its share price would likely soar if a Russia-Ukraine conflict can be averted. And in the years ahead it could generate big profits as huge infrastructure spending across the globe turbocharges demand for its metal. I simply don’t think it is a secure stock to buy if one is hunting a stable passive income.

There are many other big-yielding shares out there I think could help me generate a solid passive income. FTSE 100 construction giant Barratt Developments (LSE: BDEV) is one I’d happily spend £1,000 on today.

7.5% dividend yields!

Housebuilder Barratt is a dividend stock I actually bought several years back. And in that time it’s helped boost my passive income significantly. Demand for its new-build homes has soared in recent years thanks to the support of low interest rates and government schemes like Help to Buy. At the same time, a lack of meaningful supply has pushed property prices through the roof.

Profits have risen steadily (excluding the shock in 2020 when Covid-19 hit construction rates and sales) at Barratt. And as a consequence, the company’s had the financial firepower to pay dividends way above the market average. It’s a theme I’m expecting to continue too. Indeed, for this year (to June 2022) Barratt’s yield sits at a mighty 6.4%, way above the 3.5% FTSE 100 average. And for financial 2023 the yield jumps to 7.5%!

Latest data on the UK homes market reinforces my confidence that Barratt could remain a great dividend stock to own too. According to Rightmove, asking prices for new homes entering the market has risen 2.3% year-on-year in February. This is the highest rate of growth for at least 20 years.

Like Evraz — or indeed any other UK share — Barratt does of course expose its investors like me to some risk. The withdrawal of Help to Buy next year could hit homes demand in the years ahead, and by extension the passive income I could receive. But it’s my opinion that the potential rewards on offer from owning this FTSE 100 stock outweigh the dangers. I’d happily spend another £1,000 on the company today.

Royston Wild owns Barratt Developments. The Motley Fool UK has no position in any of the shares mentioned. 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.

I am always searching for income stocks to add to my portfolio. I am looking for companies with solid dividend credentials, large profit margins, and robust balance sheets.

Here are three income stocks that I believe now exhibit all of these qualities.

The top income stocks

In my search, I am not necessarily looking for the highest yields on the market, but those offering high-quality dividends. Cranswick (LSE: CWK) is a good example. At the time of writing, the company offers a dividend yield of 2%.

However, this is covered 2.8 times by earnings per share, giving the organisation plenty of headroom to increase the distribution further in the year ahead. It also has a strong balance sheet and lots of cash to invest in growth, which may only help improve profitability and, as a result, dividend growth. 

Sadly, this growth cannot be taken for granted. Challenges the company may face include rising prices and supply chain disruption.

Despite these potential headwinds, I would be happy to buy the food producer for my portfolio of income stocks right now. 

Green energy income

At the upper end of the yield scale is Renewables Infrastructure (LSE: TRIG). This company invests in a portfolio of renewable energy assets in the UK and Europe.

It has developed a diverse portfolio of assets over the past couple of years, taking additional investment from shareholders rather than borrowing money. This means the corporation has a solid balance sheet. As the company’s portfolio of renewable assets has grown, it has been able to increase its dividend steadily. 

At the time of writing, the stock supports a dividend yield of 5.2%. This looks incredibly attractive in the current interest rate environment. 

While the outlook for the renewable energy industry is only becoming brighter by the day, the group may have to navigate a couple of challenges over the next few years. Competition for renewable energy assets is only increasing, putting pressure on asset values. If asset values rise too much, the corporation may struggle to earn a sustainable return on its investment. This could have a knock-on effect on the dividend. 

Even after taking this potential challenge into account, this company remains one of the top income stocks I would buy today. 

Growth and income

The final company on my list is Impax Asset Management (LSE: IPX). This financial services firm has carved itself a niche in the asset management market. It focuses on offering strategies that focus heavily on ESG criteria. This approach is resonating with investors. As assets have flowed towards the business, profit has increased tenfold over the past six years. 

This trend may not continue as the rest of the financial services industry catches on to the opportunity. Staying ahead of rivals is probably the most significant challenge Impax faces right now. 

Still, I am encouraged by the company’s competitive advantages and growth potential. As profits have expanded, the firm’s dividend has also increased tenfold since 2016. At the time of writing, the stock supports a dividend yield of 2.9%.

This yield and growth potential is the reason why I rate Impax as one of my top three income stocks. 

Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

Money won’t solve our problems, but passive income will make them all a little smaller. Who wouldn’t want a little extra cash without having to work for it?

All forms of passive income take time and money, but there’s only one stream I can start today with just the leftover cash in my bank account and an hour’s work a week.

Dividend investing.

What are dividends?

Dividends are a portion of profits a company pays out to shareholders over a year. The amount paid is called a ‘yield’ and is often represented as a percentage value of the share price. So, if I own a share that’s worth £100 and the yield is 5%, I will be paid £5 per year for the share I own. It’s worth remembering that not all companies pay dividends and those that do are under no obligation to keep paying them.

Knowing my passive income goals

If I want to earn around £250 each month in dividends, then I need to know what the average UK dividend yield is and work out how much money I’ll need to invest.

Right now, that average is between 3% and 4%. There are lots of companies that pay more though, sometimes as high as 13%! However, dividends that high can be very risky. If I aim to build a portfolio with, say, an average 5% yield then I will only need £60,000 to reach my £250 a month goal.

Now, £60k is not a small amount of money, but that shouldn’t stop me from working towards it. Many share-dealing accounts let me automatically reinvest dividends. This way, I create compound interest that helps grow the portfolio. It will take time, but with patience and a little care, I can be on my way to building a passive income stream.

One hour’s work per week

It’s tempting to chase after really high-yielding stocks to boost passive income. However, as I mentioned, high-yielding stocks can come with higher risks and are often unsustainable. 

Here’s where the one hour of work comes in.

Research is key. All companies publish annual reports on their financial status and are usually very easy to find online. They can often be dry reads, but the important information is all there.

I concentrate on a company’s current free cash flows. This can be found in its annual report, which is available free online. This will determine how easily it can pay a consistent dividend. Next, how probable is it that it will be able to maintain high levels of free cash flow? This comes down to opinion mostly. But, if a firm has a long-term competitive advantage, such as a well-known brand or patented technology, itcan be a positive indicator. I also consider net debt. After all, if it has to use its free cash flows to service debt, there won’t be much left to pay dividends.

Moving to the next steps

Once I find suitable companies that meet my risk tolerance, I’m ready to start. One last thing I will do, however, is spread my investments out over several industries. No one can predict the future and one company that looks good now could fail in the years ahead. But as long as I’m careful and do my research for just one hour a week, I’m on my way to my passive income goal.

James Reynolds has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.