How I'd turn cheap shares into a lasting income stream

Buying a diverse range of cheap shares that have reliable and growing dividend payouts could lead to a lasting passive income stream, in my view.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Buying cheap shares to make a passive income stream may not sound like an appealing idea to some investors. For example, they may think that today's cheap stocks are priced at low levels because of their weak business models or poor financial outlooks.

While in some cases that may be true, in others it is far from the truth. Some low-priced shares can offer affordable dividends, growth potential and may contribute to a dependable passive income stream over the long run.

Identifying high-quality cheap shares

Assessing which cheap shares are high-quality companies may be a prudent first step in creating a long-lasting passive income. A good starting point to achieve this aim may be a company's annual report. It provides guidance on the financial position of a business, as well as other facts and figures that may shine a light on the reliability of its dividend. For example, a company that has low debt levels and a dividend that is covered more than once by net profit may offer a robust passive income outlook.

Furthermore, a company's latest investor updates paint a picture of its overall strategy. This may be especially relevant at the present time, when a number of industries are experiencing major changes. If company management has a flexible strategy that can adapt to what could be a very changeable period in the coming months, it may stand a better chance of delivering improving financial performance. This could mean that it has investment potential versus other cheap shares.

Dividend growth potential

Annual reports and investor updates can provide insight into the dividend growth prospects of cheap shares. For example, a business that pays out a small proportion of profit as a dividend may be able to raise shareholder payouts in future without necessarily increasing profitability. Similarly, a company with a sound strategy that is set to enter a new market may be able to produce improving financial performance that results in strong dividend growth.

Dividend growth could become increasingly important in the coming years. The scale of monetary policy stimulus enacted in recent months suggests that a period of higher global inflation would not be a major surprise. As such, cheap shares that can produce dividend growth may become more valuable in the eyes of investors. This may mean they offer capital growth prospects, as well as an attractive passive income outlook.

Diversifying to create a passive income stream

Of course, some cheap shares could deliver poor returns in the coming years. Even if they have solid financial positions, a competitive advantage and sound dividend prospects, unforeseen events may hold back their financial prospects.

As such, it is crucial to diversify across a wide range of businesses. This could lead to less risk, as well as higher returns in the long run.

Motley Fool contributor Peter Stephens has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Cheap Shares

Two smiling work colleagues discuss an investment or business plan at their office.
Cheap Shares

Where to invest $10,000 in a bullish share market?

High share prices shouldn't dissuade you from investing in the markets.

Read more »

A young woman lifts her red glasses with one hand as she takes a closer look at news about interest rates rising and one expert's surprising recommendation as to which ASX shares to buy
Cheap Shares

This ASX 300 stock is trading with the widest discount in its history

Bell Potter thinks this stock could be dirt cheap.

Read more »

a man with a wide, eager smile on his face holds up three fingers.
Cheap Shares

Here are my top 3 undervalued ASX shares to buy right now

These stocks are excellent picks in my opinion.

Read more »

Three cute kids with mixed expressions poke their heads out from the back of a kombi.
Cheap Shares

Three ASX shares down 10% to 23%! Are they cheap?

Price doesn't equal value.

Read more »

Smiling couple looking at a phone at a bargain opportunity.
Cheap Shares

History says these 3 ASX shares are dirt cheap today

These beaten-down ASX shares could be offering great value for money.

Read more »

Woman looking at her smartphone and analysing share price.
Cheap Shares

Why this ASX All Ords stock is 'extremely undervalued' right now

This expert is calling the market's cheapest stock.

Read more »

Man sitting in a plane looking through a window and working on a laptop.
Cheap Shares

After jumping 11% in a month, is this ASX bargain stock a buy?

This stock is on analyst radars after its FY24 results.

Read more »

A businessman looking at his digital tablet or strategy planning in hotel conference lobby. He is happy at achieving financial goals.
52-Week Lows

Why I think this ASX penny stock is a bargain at its 52-week low

This health tech share hasn't been feeling the love from the market lately. But is there an upside on the…

Read more »