In the stock market, income investing means you are picking stocks to get regular income, which is known as dividend. These dividend paying stocks are referred to as income stocks.
In other words, in income investing strategy, you are building a portfolio of dividend paying stocks specifically tailored to maximize your annual passive income.
Income stocks are not growth stocks. Both are different. You should not get confused between these two.
Income stocks give you periodical return, whereas growth stocks are for capital appreciation.
Following persons generally go for income investing strategy:
- Conservative investors
- Retirees
- Investors looking for regular return
Conservative investors are those who have a low tolerance for risk.
If you are working or self-employed, your portfolio can generate a constant stream of additional cash. For which, you need to design a portfolio of well diversified dividend paying stocks to achieve a passive income to live on.
How to find dividend paying stocks for income investing
If someone is saying that he is investing for income, it means that gentleman is picking stocks to get a dividend.
Dividend is the money paid out to the owners of the stock in proportion to their shareholding.
For example, if a company pays Rs 5 per share as dividend and you are owner of 100 shares, you are paid Rs 500.
In the stock market, you can find good stocks, which pays a higher dividend every year.
You can get dividend paying stocks from following industries;
- Food and beverage companies
- Utility companies
- Companies in Information technology sector
- Oil and gas
- Stocks from defensive sector
Defensive sectors are those that sell goods and services that are generally needed by consumers irrespective of market conditions.
What to look for in income stocks
Below we have given you certain tools and tips that can help you to analyze and select the right income or dividend paying stocks. Before investing in income stocks, you need to understand your needs first.
Income stocks are generally picked up to get regular return. If you don’t want periodical return, then better to invest in value or growth stocks which can give you better return in terms of capital appreciation in the long-term.
If you have decided to go for income stock to get regular dividend, then here are certain financial tools to help you pick the right stock;
- Dividend yield – help you assess which stock is giving or can give your more dividend in proportionate to your investment. It’s calculated by dividing the annual dividend with stock investment. You also need to compare different income stocks from the same industry to know which one is best.
- Payout ratio – it tells you what percentage of the company’s earnings are paid out in the form of dividends. Payout ratio is calculated when you divide dividend per share (DPS) by earnings per share (EPS).
Remember, you might have seen dividend yield in various financial pages. You need to keep in mind that the yield is calculated based on the change in market price. You need to calculate yield based on your investment, money you paid to get the number of shares. Your dividend yield might be different from the dividend yield shown in these financial websites.
Here are certain other important things you must look at before picking stocks for income investing;
- Company history and financial performance
- Is the management shareholders friendly and trustworthy?
- What is company’s return on equity or ROE
- How the company is maintaining its debt-to-equity ratio
Disadvantages of dividend paying stocks
Income stocks also have certain disadvantages. Here are they;
- Income stock’s price does not move much compared to a growth stock, as these are established players with less growth in top line and bottom line. Also known as blue-chip stocks.
- Government policies and political impact on these stocks can affect the bottom line of the company. For example, the government may impose regulatory hurdles for power generation companies to make sure that consumers pay less. And, the government may impose restrictions on pricing of certain key consumables, which might affect the company’s profit.
- Rising inflation will reduce the purchasing power of consumers which will affect these companies top line and net earnings. Inflation also reduces the value of your return if the company is paying the same amount of dividend irrespective of high inflation.
- Tax is another factor which reduces your take home.
Does it mean that income stocks are bad? No, you can choose the right stock by using your own strategy to minimize risks and maximize return.
Role of emergency fund in income investing strategy
You need to remember that dividend payment is not guaranteed. When a company suffers significant financial difficulties or economic downturn, its ability to pay dividend can be compromised.
Therefore, you need to make sure that you have enough money in an emergency fund to take care of your 5-6 months living expenses.
After building enough cash in your emergency fund, you should begin your income investing journey.
Based on your research you should determine what percentage of your income investing portfolio should be in dividend paying stocks and in other investment asset classes such as bond, mutual fund and real-estate.
To reduce the risk, you can consider diversifying your income investment portfolio into different other stocks and investment instruments. Instead of investing in a single company or in one industry, you can invest in a number of different companies from different industries.
One can even build a portfolio by putting together a collection of assets such as dividend paying stocks, bonds, mutual funds and real estate. Any combination that can generate the highest possible passive income is better.
