Buying stocks to earn passive income has worked for millions of people over the centuries.

This doesn’t always work: dividends are never guaranteed, so it’s vital to choose carefully.

However, by spending time and research trying to buy great companies whose shares offer both a good share price and good earnings prospects, I think I could aim to create significant long-term passive income streams even from relatively modest contributions.

If I had a spare £200 a month to put towards this plan, here’s how I’d figure an annual passive income of £7,100 in the long term.

Buying stocks that generate unrealized income

Finding the right type of stock is key to this plan. I want to buy companies that I believe can generate significant excess earnings that can be used to fund dividends in the future.

While I’m focused on income, I also want to make sure I don’t pay too much for the stock because otherwise I risk selling the stock in the future for less than I paid for it, even if I received dividends along the way.

Even the best looking stock can fail. So I would diversify my portfolio between different companies.

One stock to consider buying now

As an example of the type of stock I think investors (including up-to-date ones) should consider purchasing to create a long-term passive income stream, consider one I own: Diageo (LSE: DGE).

The company owns many premium drink brands, including: Johnnie Walker Down Smirnoff. The market for alcoholic beverages is immense and I hope it will remain so. Owning premium brands gives Diageo pricing power. This helps generate significant free cash flow. As a result, it has raised its dividend every year for over three decades.

Will this continue? Younger consumers are now drinking less alcohol than previous generations, and Diageo is considering how to address falling demand, particularly in Latin America.

However, looking at the whole picture, I’m hopeful about the long-term dividend prospects of owning the stock.

Dividends can add up!

Diageo’s dividend yield is currently 3.1%. So I’m hoping that for every £100 I invest today, I’ll earn around £3.10 in dividends per year if the payout per share stays at current levels.

In the current market, I could aim for a higher average rate of return – say 7% – by sticking to blue-chip stocks in proven companies.

If I invested £200 a month and re-invested the dividends along the way (a very powerful move called compounding), at an average rate of return of 7%, after 20 years I would have earned over £7,100 in dividends.

Now I would take the first step!

This plan seems realistic, affordable and potentially very lucrative to me.

Whether it’s £200 a month, higher or lower, my first move will now be immediate. I would set up a shares trading account or a Stocks and Shares ISA and pay regular monthly contributions.