Traditional forms of passive income like GICs (guaranteed investment certificates) and money market funds are becoming less attractive as interest rates fall. Many Canadian investors are having to head back to the stock market to capture passive income. While this does present higher risks, it also presents higher upside.
Source: Getty Images
GICs are less attractive so stocks are the place for passive income
Stocks can earn both passive income and capital gains. The combination of the two can make for a great investment. However, you do also need to be wary. Buying a stock just for a high dividend yield can be dangerous.
An elevated dividend yield (like those trading over 7%) shows the market has some serious concerns about a company’s business or financials. An elevated yield is the first warning that an investor should carefully evaluate the business before adding it.
Don’t just look at high yield stocks
Stocks that trade with a yield between 3% and 6% tend to be a safer place to look. These stocks can generate enough cash to grow their business, pay dividends, and even grow their dividends.
You also tend to get much better stock appreciation from these stocks. If their income per share rises, chances are their stock price will rise in lockstep.
How to earn $2,000 of annual passive income with a 4.5% yield
If you have a target of $2,000 of passive income, you can easily figure out how much cash you will need to invest. Simply divide $2,000 by your average anticipated portfolio yield.
A 4.5% average yield is quite attainable on the TSX today. If you divide your $2,000 target by a 4.5% yield, you will need around $45,000 invested today. The great news is that there are plenty of stocks in this range.
First Cap: A quality real estate stock
For example, First Capital Real Estate Investment Trust (TSX:FCR.UN) stock offers a 4.8% distribution yield today. It is one of Canada’s largest urban-focused, grocery-anchored landlords.
Most of the REIT’s tenants offer essential services (think grocery and value stores, banks, medical clinics, etc.). As a result, this REIT is very economically resilient. Its high-quality locations are helping it capture strong rental rate growth and elevated occupancy (over 96%).
The REIT has ample land and development assets that are still not factored into the stock price. This stock offers a nice mix of passive income and value for investors today.
Pembina: A safe and steady stock for dividends
Another example is Pembina Pipeline (TSX:PPL). It offers passive income investors a 4.7% dividend yield. It is one of the largest energy infrastructure companies in Western Canada.
A highly contracted stream of earnings helps backstop its dividend. With a low dividend payout ratio, the company has been generating a lot of excess cash. As a result, it has an industry-leading balance sheet.
This has afforded Pembina the ability to make several smart acquisitions in the past few years. Likewise, it has over $3.5 billion of high-quality infrastructure projects in the works.
These projects should support mid-single-digit growth for the next few years. For stable passive income and a steady growth outlook, Pembina is a great stock to buy and hold.
