When building a passive income stream from dividend stocks, there are two key things to keep in mind: the safety of the principal and the safety of the dividends.
How to keep your principal safe
You should aim to buy shares of proven businesses when they’re undervalued — and if you do, you’re in luck! Currently, Bank of Nova Scotia (TSX:BNS)(NYSE:BNS), Brookfield Infrastructure Partners (TSX:BIP.UN)(NYSE:BIP), and Pembina Pipeline (TSX:PPL)(NYSE:PBA) are proven businesses that are all trading at modest discounts from their fair valuations.
According to the 12-month mean price targets from Thomson Reuters, the dividend stocks have about 10% near-term upside potential. This indicates the stocks are modestly undervalued.
What makes a stock’s dividend safe?
Looking for proven businesses that tend to increase their profitability and dividends is a good start. The businesses should also have strong balance sheets and sustainable payout ratios.
Scotiabank, Brookfield Infrastructure, and Pembina are awarded S&P credit ratings of A+, BBB+, and BBB, respectively, which are all better than the minimum investment-grade rating of BBB-.
Scotiabank’s payout ratio is estimated to be about 50% this year. Brookfield Infrastructure’s funds-from-operations payout ratio is estimated to be about 60% this year. And Pembina’s payout ratio is estimated to be about 50% of operating cash flow. Compared to their respective industries, all their payout ratios look fine.
How to make $300 of passive income per month
The average dividend yield across the three stocks is 4.85%. In order to go get $300 of passive income per month (or $3,600 per year), investors need to invest $74,227 evenly across the three stocks and incur any trading fees that come with the three trades. That’s an investment of $24,743 in each of the stocks.
Scotiabank trades at $71.45 per share at writing. An investment of $24,743 would imply buying about 346 shares. Brookfield Infrastructure trades at $56.50 per unit as of writing. An investment of $24,743 would imply buying about 438 units. Pembina trades at $48.91 as of writing. An investment of $24,743 would mean buying about 506 shares.
By holding a diversified basket of dividend stocks that have a track record of paying safe dividends, investors can pretty much guarantee to earn a growing passive income stream.
Investors can start off investing $74,227 evenly across the stocks of Scotiabank, Brookfield Infrastructure, and Pembina Pipeline to get an initial amount of $300 per month.
That’s a big lump sum to invest at one time. The important thing is to start investing for a passive income stream. You might start with earning $100 or even $10 a month. If you keep building that passive income stream, before you know it, it’ll become $300 a month or even $3,000 a month.
Remember that these quality dividend stocks tend to increase their dividends. You can count on them increasing their dividends by at least 5% per year. That’ll also help you boost your passive income on top of any new money you invest for dividends.
When you buy heavily cyclical stocks at low prices… and then hold the shares until the cycle reaches its peak… you can make a very healthy profit.
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Fool contributor Kay Ng owns shares of Brookfield Infrastructure Partners, Pembina Pipeline, and The Bank of Nova Scotia. Brookfield Infrastructure Partners and Bank of Nova Scotia are recommendations of Stock Advisor Canada. Pembina is a recommendation of Dividend Investor Canada.