There are a lot of options available for building a passive income. But most require quite considerable time and dedication to achieve, especially for those who decide to start their own business. I prefer the far less time-consuming investing route using a Stocks and Shares ISA.
By buying established, high-quality, and large-payout dividend stocks, I can quickly put together a diversified portfolio generating passive income. And, best of all, I’d only have to do about five minutes of reading each week to keep track of things. Of course, this isn’t risk-free and can end up going sideways. So let’s explore the dos and don’ts of this approach.
I’d only buy mature industry leaders
Since my goal is passive income, I’m only really interested in buying shares that pay dividends. While it’s less common, there are young businesses out there that do this. But, personally, I’m avoiding these types of companies for my passive income portfolio. Let me explain why.
Dividends should only be paid to shareholders out of the excess capital of a business. In other words, only return money to investors if there is no better use for it internally. Young companies are typically in high-growth mode and can have unstable income.
In my experience, that’s not the hallmark of an investment capable of paying a consistent and growing dividend. This is why I prefer mature businesses for a passive income strategy. The growth rate might be slow, but it does come with consistency.
Note that I emphasised the word ‘should’ earlier. That’s because even a mature business may suffer through a down period. And every once in a while, there have been cases where a bad management team decides to take on debt to maintain dividends.
In my eyes, this is a giant red flag. Yes, it keeps my passive income flowing in the short term, but in the long run, it’s not sustainable and damages the business’s financial health.
Needless to say, that’s not a desirable trait for a portfolio built to generate sustainable passive income for years, or even decades, to come.
Which passive income stock should I buy?
In my opinion, boring is always best. A simple boring consumer goods business like Unilever (LSE:ULVR), the group behind the Ben & Jerry’s ice cream and Dove shampoo, isn’t going to be a source of explosive growth. But its vast amount of brand loyalty keeps its customer coming back for more. And that generates significant pricing power against the margin pressure of inflation.
Today, I could buy shares and enjoy a 3.9% dividend yield that has been steadily climbing over the last 10 years, even during the pandemic. Of course, past performance is a pretty poor indicator of what could happen in the future. And suppose the company isn’t able to produce premium products that are superior to cheaper alternatives. In that case, brand loyalty may start to waver over time.
It’s a risk to consider. But one worth taking, in my opinion. That’s why I think Unilever could be one of the best passive income stocks to get started with when building my dividend portfolio.
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Zaven Boyrazian has no position in any of the shares mentioned. 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.
