Want More Passive Income in 2025? Consider This ETF and 2 Rock-Solid Dividend Stocks.

The S&P 500 notched a rip-roaring 53.2% gain in the two-year period from 2023 through 2024. Passive income collected from most dividend stocks during this period pales in comparison to the capital gains of the broader market.

The best way to approach investing in dividend stocks isn't to try to keep pace with a red-hot rally, but rather to invest in balanced companies that have the potential to grow earnings over time and, in turn, their payouts to investors. The advantages of dividend stocks are put on display when the broader market is having a mediocre or down year. In those cases, income earned from dividend stocks or dividend-paying exchange-traded funds (ETFs) can effectively supplement income in retirement or provide some extra dry powder to reinvest in the market.

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Here's why Honeywell International (NASDAQ: HON), American Electric Power (NASDAQ: AEP), and the Energy Select Sector SPDR Fund (NYSEMKT: XLE) are three excellent buys for 2025.

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Honeywell is finally giving investors something to smile about

Daniel Foelber (Honeywell): Honeywell checks most boxes for stocks to buy in 2025. The industrial conglomerate has a diversified business in aerospace, industrial and building automation, Industrial Internet of Things, energy and sustainability solutions, and more.

The stock has a reasonable valuation, with a price-to-earnings (P/E) ratio of 26.2 and a forward P/E ratio of just 20.6. And Honeywell has 14 consecutive years of dividend raises and a yield of 2% -- which is above the S&P 500 yield of 1.3% and the 1.1% yield of the Vanguard Industrials ETF, which tracks the industrial sector.

However, Honeywell doesn't have a recent track record for growth or a clearly defined runway for future growth. Despite focusing on bridging the gap between industrial equipment and software, Honeywell has failed to achieve meaningful earnings growth. Diluted earnings per share is up just 58.6% in the last decade and revenue is down during that period. Honeywell has expanded its operating margins, but still the growth has been largely disappointing.

Honeywell's solution has been to make a flurry of acquisitions to accelerate growth. The acquisitions could take time to pay off, and have come at a cost, as Honeywell's balance sheet has become more leveraged -- with debt-to-capital and financial debt-to-equity ratios at all-time highs.

Following a wave of break-ups across the industrial sector, Honeywell is now considering spinning off its aerospace segment, which could unlock value by improving the pace of innovation. We'll know a lot more when Honeywell reports fourth-quarter and full-year 2024 earnings in late January or early February. However, splitting the company into more focused businesses could finally help Honeywell move closer to becoming an industrial technology company and less of a legacy stalwart.

All told, now is a great time to buy Honeywell if you're looking for a way to invest in the Industrial Internet of Things without overpaying for a high-flying growth stock.

American Electric Power is a high-yield dividend stock that's sitting in the bargain bin

Scott Levine (American Electric Power): With the different priorities that individual investors have, it's impossible to characterize any dividend stock as "perfect." But American Electric Power comes pretty close. In addition to its hefty payout -- the forward dividend yield is over 4% -- American Electric Power has demonstrated a long history of rewarding shareholders, suggesting that it's well equipped to continue doing so. Plus, the company's business model is simple and reliable, a great combination for conservative investors looking to jolt their passive income streams.

American Electric Power's returning of capital to shareholders through a dividend is no flash in the pan. The company has strung together a streak of 114 years of making quarterly dividend payments. Over the past decade, management has shown an especially sincere commitment to rewarding shareholders, hiking the dividend at a 5.8% compound annual growth rate.

Looking ahead, management is targeting dividend growth consistent with the expectation that it will grow operating earnings at 6% to 7% annually. Those still skeptical of the high-yield dividend can further rest assured that management isn't imperiling the company's financial well-being. American Electric Power's payout ratio has averaged 70% over the past five years, and management has targeted a payout ratio of 60% to 70% in the years ahead.

Since the company mostly operates in regulated markets, it guarantees certain rates of return; thus, investors can have confidence in management's forecast for earnings growth. But that's not all. With interest in artificial intelligence skyrocketing, American Electric Power sees an excellent opportunity for commercial sales to grow in the near future, thanks to the rise in data center power usage. In 2025 alone, commercial sales are expected to grow 7.6% year over year.

This oil ETF is a great way to get broad-based exposure to energy

Lee Samaha (The Energy Select Sector SPDR ETF): There is ongoing debate around the future direction of the price of oil, but it's worth taking a step back and acknowledging that the current price above $70 a barrel is favorable for oil exploration and production companies. This means that oil companies can gush cash flow and support healthy dividends to investors.

This is also why the Energy Select Sector SPDR ETF pays a 3.3% dividend yield. The ETF holds 22 energy companies, with ExxonMobil (23% of the ETF), Chevron (15.3%), and ConocoPhillips (8.1%) as its top three holdings. A quick look at these stocks' price-to-free-cash-flow (FCF) multiples shows how cheap they are.

By way of argument, consider that Chevron's price-to-FCF multiple of 14 implies it's generating 7.1% of its market cap in FCF. In theory, at least Chevron could pay a 7.1% dividend yield.

XOM Price to Free Cash Flow data by YCharts

However, the reality is Chevron won't commit all its FCF to its dividend as the price of oil has historically proven to be volatile. That said, unless you have a negative view of oil, this ETF looks like an excellent option for dividend-seeking investors, and the spread of investments helps diversify away the stock-specific risk of buying just one stock.

Don’t miss this second chance at a potentially lucrative opportunity

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Right now, we’re issuing “Double Down” alerts for three incredible companies, and there may not be another chance like this anytime soon.

See 3 “Double Down” stocks »

*Stock Advisor returns as of January 6, 2025

Daniel Foelber has no position in any of the stocks mentioned. Lee Samaha has no position in any of the stocks mentioned. Scott Levine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chevron. The Motley Fool has a disclosure policy.