As a committed Fool, I reckon passive income is best achieved via the stock market. The task dividend hunters face, of course, is identifying which stocks to buy.
For my part, I feel that smaller companies are often unfairly ignored in favour of established FTSE 100 plodders. Accordingly, here are two examples of the former I might consider.
Passive income provider
Miner Central Asia Metals (LSE: CAML) is first up. The diversified base metals producer operates a copper facility in central Kazakhstan. It also owns the Sasa zinc and lead mine in North Macedonia.
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For those who believe that demand for metals (and particularly copper) is only going to rise in the years ahead, CAML’s outlook could be very positive indeed. This could/should lead to improving free cash flow and, as a consequence, steadily rising dividends for passive income seekers.
Central is currently predicted to return 14p per share this year. That’s a chunky yield of 5.7%. For perspective, the best Cash ISA pays out a ludicrously low 0.65%. What’s more, this handout looks likely to be covered over twice by profit, making it, in theory at least, very secure.
The investment case is further boosted when considering the valuation. A P/E of just under 8 looks seriously cheap, given CAML’s relatively low net debt and consistent operating margins of over 40%.
Cheap market leader
Another small-cap option that’s grabbing my attention is collagen product manufacturer Devro (LSE: DVO).
Put simply, the £350m-cap provides the casing used in the production of sausages. That clearly doesn’t grab the attention in the same way as a glitzy tech stock. Then again, I’d probably prefer to own a global leader in a niche market rather than an unprofitable business in a highly competitive space.
Despite rising 33% in value over the last year, DVO shares trade on a little less than 13 times earnings. That looks good value to me. Returns on capital and operating margins have been improving in recent years. Debt has also been coming down.
As far as passive income is concerned, analysts have the company returning 9.27p per share for the current financial year. That’s a tasty yield of 4.4% at DVO’s current share price. Importantly, this payout is expected to be covered 1.8 times by profit. Like at CAML, that suggests dividends will actually be paid. To me, that’s far more preferable to firms promising too much and not delivering.
Never risk-free
Sure, no dividend stream is guaranteed. In fact, it can be one of the first things to be sacrificed when the going gets tough. It’s also worth highlighting other, more specific, drawbacks to investing here.
As far as CAML is concerned, the company clearly has no control over a volatile copper price. Moreover, mining is a notoriously tough sector, both in a physical and financial sense. The possibility of operations being interrupted by rising Covid-19 cases can’t be dismissed either.
Pandemic aside, DVO arguably doesn’t share these risks. However, it’s worth noting that the company hasn’t hiked its dividend by much over the years. Ideally, I’d want a payout to be increasing in order to outpace inflation. It’s not a killer blow, but it’s something to consider.
So, while I do rate both stocks as being cheap sources of passive income, the importance of staying suitably diversified shouldn’t be overlooked.
