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Ithaca Energy (LSE:ITH) is the type of stock that attracts the attention of investors looking to generate passive income. This is because the oil and gas producer paid a dividend of $0.40 per share (31.3 pence at the current exchange rate) for the year ending December 31, 2023 (FY23).
If this repeats itself during FY24, it means the stock is currently returning a whopping 24.7%.
The dividend cost the company approximately $400 million. However, it recently announced a deal that will see it acquire Eni UK's upstream assets. If completed, the company expects to return at least $500 million to shareholders in 2024.
Crunching the numbers
But for the purposes of my example, I'm going to assume that the $0.40 dividend is retained over a 20-year period.
On the basis that the share price does not change (and that all dividends are reinvested by buying more shares in the company), my hypothetical £20,000 would become £1.65 million in two decades.
At that point, a 24.7% annual return would give me an income of £40,829, equivalent to £3,402 a month.
Wow!
The million dollar question
So, to answer the question posed in the headline of this article, yes, Ithaca Energy could turn £20,000 of savings into passive income of over £3,000 a year. But this conclusion comes with a series of caveats.
First of all, dividends are never guaranteed. The company did not list until November 2022. Therefore, it does not have a long history of offering generous payouts that can be trusted.
A stock offering a double-digit return could be a value trap, something that looks like a bargain but is actually anything but. Rarely is such impressive performance sustainable.
Furthermore, I think it would be unwise to put all my hypothetical £20,000 into one share. Diversification is a way to spread risk across several stocks. Having an investment means that success (or failure) depends on a single company. Things could go terribly wrong.
This is particularly true for Ithaca Energy, which operates in a highly volatile industry where profits depend almost entirely on oil and gas prices.
To try to provide some certainty about its income, the company enters into hedging agreements with customers. As of March 31, 2024, the sale price of just over a third of its annual production had been agreed in advance.
But for a company to maintain a healthy dividend it needs to remain profitable and generate cash. And this is where Ithaca Energy faces a unique challenge. Because it generates most of its income in the North Sea, its profits are subject to a penal tax rate of 75%. This probably explains why its share price has fallen 45% since its stock market debut.
Final thoughts
As I believe there are other less risky sectors to invest in, I do not want to buy shares of the company.
However, there are alternative ways to generate generous levels of passive income from high-yield stocks.
For example, there are many FTSE 100 stocks that currently offer returns of 6% to 8%. In 20 years, reaching the top of this range would turn £20,000 into a monthly income of £621.
Therefore, I will continue to look for other dividend stocks to include in my portfolio.