{"id":962,"date":"2010-10-16T20:49:45","date_gmt":"2010-10-17T00:49:45","guid":{"rendered":"http:\/\/thestockmarketwatch.com\/learn-stock-market\/?p=962"},"modified":"2016-04-26T14:41:58","modified_gmt":"2016-04-26T18:41:58","slug":"stock-picking-strategies-income-investing","status":"publish","type":"post","link":"https:\/\/www2.stockmarketwatch.com\/learn\/stock-picking-strategies-income-investing\/","title":{"rendered":"07) Stock Picking Strategies: Income Investing"},"content":{"rendered":"

The goal of income investing: pick a stock that provides steady income.\u00a0 It is perhaps the most straightforward way of picking stocks.\u00a0 Aside from fixed securities and bonds, stocks can also provide a steady income for investors.\u00a0 Let us look into the strategy of finding these stocks.<\/p>\n

The Dividends<\/strong><\/p>\n

Income investors usually look towards established companies.\u00a0 These are old, established and reputable.\u00a0 They have very little room for higher levels of growth and are not in industries that are rapidly expanding.\u00a0 So instead of reinvesting retained earnings on the company, they pay out dividends to shareholders instead as a means to provide a return.<\/p>\n

Dividend Yield<\/strong><\/p>\n

Income investment does not automatically mean that you invest in the company that pays the highest dividend.\u00a0 You instead take a look at the dividend yield which is the annual dividend per share by share price.\u00a0 This gauges the actual return a dividend gives the owner of the stock.\u00a0 Example, a company has with a share price of $100 has a $6 dividend share and a 6% dividend yield or a 6% return on the dividend.\u00a0 Average dividend yield of companies in the S&P500 is 2-3%.<\/p>\n

However, a 2-3% return is not enough for income investors.\u00a0 They are looking for companies that provide at least a 5% return on their investment.\u00a0 This means that if a person invests $1M his investment would yield (before taxes) $50,000-$60,000.\u00a0\u00a0 The principle behind this strategy is simple: find good companies with high dividend yield and receive a steady stream of income over the years.<\/p>\n

Another thing to consider is a company’s dividend policy.\u00a0 Try to determine whether a company can sustain their dividend yields for the years to come.\u00a0 If a company suddenly increases the rate of dividends over a short period of time, this might be too optimistic.\u00a0 A good rule of the thumb:\u00a0 the longer a company has been paying good dividend, the more likely it will continue to do so.<\/p>\n

Johnson & Johnson for example have been paying great dividends and increasing dividend rate over the years.\u00a0 From 1963-2004, they have been steadily increasing their dividends each year.\u00a0 If you bought the stock in 1963, your dividend shares would have grown 12% yearly.\u00a0 In 30 years it would have reached a 48% return on your initial shares!<\/p>\n

Critics of the income investing technique say that this strategy is too conservative.<\/p>\n

The Downside of Dividends<\/strong><\/p>\n

Dividends aren’t everything.\u00a0 A high dividend does not mean it\u2019s a good company.\u00a0 Because dividends come from the company’s net income, it could result to lower retained earnings.\u00a0 Problem usually develops when reinvesting that money would have been better compared to paying higher dividends.<\/p>\n

Income investing is a good stock screener when you want to look for companies with good dividend yield.\u00a0 Investing on these companies are good especially if they have provide good and sustainable dividend yield.\u00a0 This is why investors should analyze a company’s fundamentals thoroughly.<\/p>\n

Also, dividend yields do not equal low risk.\u00a0 Risk is still involved especially when dealing with high dividend yields.\u00a0 This risk can be minimized by picking solid companies.<\/p>\n

Dividend yields are also taxable.\u00a0 They have the same rate as your salary. Therefore these are taxed higher than capital gains which can make your final cut a bit lower than originally expected.<\/p>\n