Dividend investing can be a perfect way to earn passive income. I started this blog years ago, intending to earn passive income from dividend stocks. That’s why I chose the domain name passive-income-earner.com. However, I wasn’t investing for passive income initially.
I failed to set the criteria for passive income investing — something like the following. First, the dividend stock should provide a sufficient yield. Second, the business cannot be so volatile that there’s a chance of a dividend cut. Third, the stock should allow you to sleep well at night.
Does the dividend stock have a big enough yield?
Some dividend stocks, even though, they’re backed by quality businesses, are not good for passive income. For example, Canadian Pacific Railway (TSX:CP)(NYSE:CP) yields only 0.8%. The best five-year GIC rate is going for 2.3%. So, I would require a dividend stock with a yield of at least 3% for passive income.
To be clear, I believe CP is a good long-term total-return investment — just not a good passive income investment. CP transports products like automotive, metals, energy, chemicals, fertilizers, coal, and grain. It should remain a good business until we can teleport things safely.
Additionally, it will soon be joining hands (I mean, rails) with Kansas City Southern, forming Canadian Pacific Kansas City, the first rail network to connect Canada, the U.S., and Mexico, which brings unique competitive advantages. Notably, though, the merger still requires shareholder approval from both railway companies. If the voting goes smoothly in December, the transaction should close in the second half of 2022, after the Surface Transportation Board (STB) gives final approval.
CP’s above-average growth can lead to significant passive income down the road for investors who have a long investment horizon. For instance, the dividend stock’s 10-year dividend growth rate is 12.9%, despite keeping its dividend the same between 2013 and 2015.
Does it have volatile business performance?
Many stocks pay dividends. Why do some end up cutting dividends? It’s because of their volatile earnings. It’s crystal clear that there are higher percentages of dividend cuts from oil and gas products and mining companies over any business cycle. So, don’t buy these stocks as passive income investments even when they offer enticing yields.
For example, Suncor Energy (TSX:SU)(NYSE:SU), a diversified energy company, was a Canadian Dividend Aristocrat until it cut its dividend during the pandemic last year. It couldn’t be helped as its free cash flow turned negative in 2020. Management had higher priorities than protecting the dividend.
Investors should note that Suncor was still a plausible investment. If you bought it at a low of, say, $16 per share, you would be sitting on gains of 81%, plus the dividends you received.
It’s a different story if you’re buying this type of dividend stock for total returns with a focus on price appreciation — that is, aiming to buy low and sell high.
Are you sleeping well at night?
It doesn’t work if your neighbour gave you a tip about a great dividend stock that is a predictable passive income generator of a +3% yield if you can’t sleep well at night because of it.
It may be because you’re unfamiliar with the actual business. If so, you can read up more on it. Other times, it might be that you allocated too much of your money in the position. If that’s the case, simply take some money off the table, ideally, at a good valuation to sell.
If for some other reason, you can’t sleep well at night because of a stock, you’ve got to ask yourself is it worth losing sleep over it.
One more thing
Alright, so, some work is still needed for this passive income strategy. For a passive income dividend investing strategy, you need to decide when to buy and keep up with what the business is doing to ensure it’s still paying safe (and ideally growing) dividends.
But if you think about it, which passive income strategy doesn’t require some work? Hopefully, it wouldn’t feel like work, if you’re passionate about dividend investing. 😉
If you like what you've just read, consider subscribing via the "Subscribe Here" form at the top right so that you will receive an email notification when I publish a new article.Disclosure: As of writing, we own shares of CP.
Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
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