Just how much passive income can someone hope to earn by putting some money into the stock market on a regular basis and buying dividend shares?

The answer will depend on a few things.

One is timeline. For this example, I will presume they contribute for a decade.

A second factor is the average dividend yield. Here I will presume 5%, above the current FTSE 100 average of 3.1% but still realistic in my opinion even when sticking to blue-chip shares.

How much to invest – and what about reinvesting?

The third factor is how much they invest.

At £3 a day, the next decade should see passive income of £2,714. At £10 a day, that goes up to £9,049. Someone putting in £50 a day for a decade ought to earn £45,245 of passive income in the coming decade.

That is just the passive income, remember – the money they have put into the shares will hopefully mean the portfolio also has value, although of course share prices can move down as well as up.

But there is something about this example that I now want to zoom in on.

So far, I have presumed that the investor takes all the dividends out as passive income as they earn them.

What if they did not do that, but instead reinvested them along the way?

Compounding gains can help investors build wealth

That is known as compounding.

This is a simple but powerful technique, as we can learn from this example.

Say the investor puts the same amount of money away in the coming decade and earns the same 5% yield, but instead of taking the dividends as passive income reinvests them along the way.

A decade from now, £3 a day ought to have built a portfolio worth £14,088. At a 5% yield, that could then earn £704 of passive income annually.

£10 a day should have build a portfolio of £46,960: enough to then generate £2,348 of passive income per year.

Meanwhile, £50 a day should mean a portfolio worth £234,807. At a 5% yield, that could then produce £11,740 per year in passive income. That is almost £1,000 per month of passive income!

Clearly, compounding can be a powerful force multiplier when it comes to building passive income streams!

Putting the plan into action

While the numbers are interesting, just thinking about them does not produce passive income!

A useful first step in putting the plan into action could be setting up a share-dealing account, Stocks and Shares ISA or trading app. Then someone can start contributing money and buying shares.

One income share I think is worth considering right now, for those who are not ethically opposed, is British American Tobacco (LSE: BATS).

Manufacturing cigarettes is cheap but thanks to its premium branding and market pricing, the firm can sell them for a pretty penny.

British American is massively profitable and has grown its dividend per share annually for decades. At 6.1%, its yield is well above the 5% I used in my example above.

With cigarette volumes in decline, coming years could see both revenues and profits fall.

However, the FTSE 100 company has long experience of navigating complex, shifting markets – and has been expanding its non-cigarette business.

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Christopher Ruane does not hold any positions in the companies mentioned.