If you are looking for a way to earn recurring passive income, stocks might be a suitable option – as long as you do your homework and research the companies you’re investing in, as well as familiarise yourself with the strategies and pros and cons of delving into the stock market.
Here are five characteristics of stocks you should look out for to successfully obtain recurring dividends.
1. Solid business models
Find companies with business models that enable you to earn a recurring income. To illustrate this, let’s use the metaphor of property developers versus property-holding companies.
The former typically buy land and develop real estate. Once the development is completed and handed over to buyers, that’s the end of their source of income.
Property-holding companies or real estate investment trusts, on the other hand, own and rent out their properties to commercial tenants for a period of time. Their business model allows them to earn recurring income over the long term.
So look for “property-holding companies”, not “developers”.
2. Big customer pools
Invest in stocks that have a large pool of customers. Imagine two companies, A Bhd and B Bhd, both reporting RM500 million in revenue in a single year. A Bhd generated it from 10 million customers, while B Bhd generated it from 10 key clients.
Opt for A Bhd as it has a larger pool of customers, making it less likely to be financially impacted in the event of a loss of or payment default by a customer.
3. Cash-sale businesses
Opt for cash-sale over credit-sale businesses.
Stocks that collect cash from customers are ideal for investors as they have enough money to reward shareholders over the long term. Stocks that are bad with cash collection could end up in a tight cash-flow situation and would be unable to pay dividends regularly.
4. Consistent growth
Stocks must generate consistent growth in earnings to pay out dividends to shareholders over the long term.
Ten years is a benchmark to measure consistency as many incidents could happen over this period, such as the rise and fall of currencies, or prices of oil or essential materials; fluctuations in interest rates; changes in political, economical or social policies; tech advancements and shifts in consumer behaviour; trade tensions, pandemics, and much more.
A stock that you invest in should be able to deliver consistent growth despite all of the above.
5. Positive cash flow
This consistent growth in earnings has to be backed by years of positive cash flow from operations. If a stock has had consistent earnings growth over the past decade but has negative operating cash flow, do not invest in it.
An exception would be the stocks of banks or financiers, who would record consistent operating cash outflow once they disburse loans to their borrowers.
This article first appeared in KCLau.com.
Ian Tai is a financial content writer, dividend investor, and author of over 450 articles on finance featured in KCLau.com in Malaysia, and ‘Fifth Person’, ‘Value Invest Asia’ and ‘Small Cap Asia’ in Singapore. He is a regular host and presenter of a weekly financial webinar in KCLau.com.