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I often mention my desire to build a portfolio that can deliver consistent passive income. This is a great way to diversify from traditional growth and value holdings. The ability of a small number of high-quality holdings to provide an income month after month can make a big difference during those tough market conditions.
Growth stocks can lose momentum. This results in the share price falling, leaving just two options: hope for a recovery or sell the position. Likewise, a value investment may take years before the market capitalisation catches up to its true value. This is why income holdings can be of great benefit to my portfolio. Regardless of the share price, dividends should continue to be paid each month or quarter.
What I’m looking for
Despite how simple this strategy may appear, it involves looking at several factors to find a consistent income-generating holding. I’m looking for simple, high-quality companies whose business models aren’t difficult to understand and who I can trust to pay a dividend continually. For me, a high-quality business will generate plenty of cash flow, have strong earnings growth, and sensible profit margins.
Of course, it’s essential not to forget the dividend itself. For this reason, I have a few requirements when it comes to the yield being offered. I want to see a dividend that has been paid and grown consistently for many years. This track record is vital, as I want to be able to rely on this company’s dividend for many years.
My latest find
A prime example of what I’m looking for is Drax Group (LSE: DRX). It is a UK-based company focused on renewable energy generation. It has experienced impressive share price growth over the last two years, growing over 61% in 2021. However, it is now down almost 7% this year and over 32% from its peak at the beginning of 2022. Despite this, the price-to-earnings (P/E) ratio is currently 25.5, although it is forecast to reach just 6.9 by next year.
The underlying fundamentals are also strong, with good levels of free cash generation and reasonable profit margins. Additionally, turnover is forecast to grow by 26% next year, and earnings per share (EPS) is expected to increase by 267%. These impressive forecasts support the idea the current dividend is secure and likely to grow further.
The current yield of 3.3% has been paid consistently for the last 16 years and has grown for the previous five. The dividend cover ratio of over one suggests that this level can be paid comfortably with current EPS. The dividend is also forecast to grow by over 11% next year, reaching 3.8%. This new level can still be comfortably covered by EPS, giving a dividend cover forecast of just under four.
My conclusion
It is essential to note that the current share price level is relatively high, so if the expected EPS and turnover growth aren’t achieved, the current price-to-earnings ratio could make the stock overvalued. Also, the current debt level is almost 70% of market capitalisation, so I want to keep an eye on these.
Nevertheless, this is an excellent opportunity to access a consistent dividend yield. I will add the company to my portfolio once I get the necessary funds.
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