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Diversification is the cornerstone of my passive income investing strategy. Since dividends are not guaranteed, I spread my stock market positions across a variety of companies and sectors.
Consequently, I hope to ensure a steady stream of dividend payments even if some companies I invest in encounter financial difficulties. Ultimately, going all-in on a single stock is an extremely risky approach and too rich for my blood.
Nevertheless, it is an interesting thought experiment. What if you could only choose one dividend stock to buy? What stocks would I feel most comfortable investing all my cash in?
After serious deliberation, I decided on Europe's largest defense contractor, BAE Systems (LSE:BA.).
This is why.
Dividend Reliability
Offering just a 2.3% dividend yield, BAE stock might not be an obvious choice for those looking for passive income. In fact, the company's performance is lower than the average return of 3.7% across FTSE 100 stocks.
But listen to my logic. If I were to concentrate my entire passive income portfolio into a single stock, I would prioritize dividend stability over a high yield that might not be sustainable in the long term.
In this sense, the weapons manufacturer does not disappoint. It's a Dividend Aristocrat, boasting a 30-year unbroken streak of increasing distributions to shareholders.
Most recently, the company increased its annual dividend for 2023 by 11% to 30p. Additionally, BAE continues to drive shareholder returns through an ongoing £1.5bn share buyback programme.
Looking ahead, the expected dividend coverage looks healthy, standing at 2.1 times earnings. That's above the two-fold threshold generally considered to indicate a wide margin of safety. Impressive stuff.
Defensive qualities
I also like the non-cyclical nature of the company's operations. Many dividend stocks rise and fall according to macroeconomic cycles, but BAE's fortunes are more closely tied to the military spending of its government clients around the world.
This makes the stock particularly attractive currently, considering the UK economy has entered a recession at the end of 2023.
It's true that some investors may have moral concerns about a company that specializes in manufacturing fighter jets, missiles, warships and munitions.
That's understandable. However, there is little to deny the current rise of this sector due to the high geopolitical risks and the tragic ongoing wars in Ukraine and the Middle East.
Perhaps then it is not surprising that BAE's share price has grown by 157% in five years. Looking ahead, the company's future also looks bright.
Impressive recent contracts, such as a £4bn order under the AUKUS defense pact for a new generation of nuclear submarines, took order intake in 2023 to a record £37.7bn. BAE's order book is also at a record level of £69.8bn.
Risks
Despite reasons for optimism, it's worth noting that the company's forward price-to-earnings (P/E) ratio of 19.4 is higher than its historical average. This could indicate lower future returns.
Furthermore, BAE is no stranger to controversy. The historic corruption scandal over the Al-Yamamah arms deal with Saudi Arabia comes to mind.
Additionally, Indian authorities are currently investigating allegations of “criminal conspiracy”against BAE and Rolls-Royce in connection with the acquisition of advanced Hawk 115 training aircraft in 2005.
However, I believe BAE Systems deserves consideration for any investor's passive income portfolio. It's right at the top of my list, but I would diversify to mitigate the risks.
