Income Stocks

Income Stocks

Income stocks are appealing simply because of the dividends they pay.

These issues have a long history of regularly paying higher than average dividends.

Income stocks are ideal for those who seek a relatively safe and high level of current income from their investment capital.



Growing dividends protect from effects of Inflation

Holders of income stocks (unlike bonds and preferred stocks) can expect the dividends they receive to increase regularly over time.

Thus, a company that paid, say, $1.00 a share in dividends in 1997 would be paying just over $1.80 a share in 2012, if dividends had been growing at around 4% per year.

Dividends that grow over time provide investors with some protection from the effects of inflation.



Major Disadvantage: some have Limited Growth Potential

The major disadvantage of income stocks is that some of them may be paying high dividends because of limited growth potential.

Indeed, it is not unusual for income securities to exhibit relatively low earnings growth.

This does not mean that such firms are unprofitable or lack future prospects.

Quite the contrary:   Most firms whose share qualify as income stocks are highly profitable organizations with excellent prospects.

A number of income stocks are among the giants of U.S. industry, and many are also classified as quality blue chips.




Risks

By their nature, income stocks are not exposed to a great deal of business and market risk.

They are, however, subject to a fair amount of interest rate risk.

Examples

Many public utilities are in this group, such as:

• American Electric Power,
• Duke Energy,
• Oneok,
• Scana,
• DTE Energy, and 
• Southern Company.

Also in this group are selected industrial and financial issues like:

• Conagra Foods,
• General Mills, and
• Altria Group.

The Disadvantages of Stock Ownership

There are some disadvantages of common stock ownership.

1.  Risk

Risk is perhaps the most significant.

Stocks are subject to various types of risk, including:

• business and financial risk,
• purchasing power risk,
• market risk and 
• event risk.

All of these can adversely affect 

• a stock's earnings and dividends, 
• its price appreciation and 
• of course, the rate of return that you earn.

Even the best of stocks possess elements of risk that are difficult to eliminate because company earnings are subject to many factors, including:

• government control and regulation,
• foreign competition and
• the state of the economy.

Because such factors affect sales and profits, they also affect stock prices and (to a lesser degree) dividend payments.

2. Price & Returns Volatility

All of this leads to another disadvantage: stock returns are highly volatile and very hard to predict, so it is difficult to consistently select top performers.

The stock selection process is complex because so many elements affect how a company will perform.

In addition, the price of a company's stock today reflects investors' expectations about how the company will perform.

In other words, identifying a stock that will earn high returns requires that you not only identify a company that will exhibit strong future financial performance (in terms of sales and earnings) but also that you can spot that opportunity before other investors do and bid up the stock price.

3. Current income

A final disadvantage is that stocks generally distribute less current income than some other investments.

Several types of investments - bond, for instance - pay more current income and do so with much greater certainty.

Comparing the dividend yield on common stocks with the coupon yield on high grade corporate bonds from 1976 to 2012,  shows the degree of sacrifice common stock investors make in terms of current income.

Clearly, even though the yield gap has narrowed a great deal in the past few years, common stocks still have a long way to go before they catch up with the current income levels available from bonds an most other types of fixed-income securities.

Message:  

In other words, identifying a stock that will earn high returns requires that:

• you not only identify a company that will exhibit strong future financial performance (in terms of sales and earnings) 
• but also that you can spot that opportunity before other investors do and bid up the stock price.

Uses of Common Stocks: as storehouse of value, to accumulate capital and as a source of income

Basically, common stocks can be used as:

1.  a "storehouse" of value,
2.  a way to accumulate capital, and,
3.  a source of income.


Storage of value

Storage of value is important to all investors, as nobody like to lose money.

However, some investors are more concerned about losses than are others.

They rank safety of principal as their most important stock selection criterion.

These investors are more quality-conscious and tend to gravitate toward blue chips and other non-speculative shares.


Accumulation of capital

Accumulation of capital, in contrast, is generally an important goal to those with long-term investment horizons.

These investors use the capital gains and/or dividends that stocks provide to build up their wealth.

Some use growth stocks for this purpose, while others do it with income shares, and still others us a little of both.


Source of income

Finally, some investors use stocks as a source of income.

To them, a dependable flow of dividends is essential.

High-yielding, good-quality income shares are usually their preferred investment vehicle.




Individual investors can use various investment strategies to reach their investment goals.

These include:

1. buy and hold,
2. current income,
3. quality long term growth,
4. aggressive stock management, and 
5. speculation and short term trading.

The first 3 strategies appeal to investors who consider storage of value important.

Depending on the temperament of the investor and the time he or she has to devote to an investment program, any of these strategies might be used to accumulate capital.

In contrast, the current income strategy is the logical choice for those using stocks as a source of income.

Income Investing - The Power of Dividends

Income Investing: How do you plan to pay for your retirement?

Imagine that you're 65 years old and you're looking to retire.

If you have $500,000 in savings, how long will that money last?

If you spend $50,000 a year and your saving grows at 7% a year, you'll be broke by age 80.

The savings and investments can only support you for 15 years from the age of 65!!!


What is Income Investing?

Income investing is purchasing stable stocks and bonds that pay dividends and coupons.  If enough stocks and bonds are acquired, the dividends and coupons will provide income for the owner during retirement.

If the income is enough to meet spending requirements, then the equity and par value of the investments will remain or grow with time as income payments continue to grow as well.

How can you invest in companies that will provide benefits now and into retirement?  

Invest in stable companies with low debt/equity ratio that pay dividends.

Always purchase assets that will increase your cash flow next month.  Income investing has a compounding effect in increasing your cash flow.  Using this approach will provide increasing liquidity (dividends) each month, so you can invest in the most undervalued security (either stocks, bonds, or preferred shares).

Conclusion

Income investing provides quarterly payments during retirement.

Income investing provides a constant stream of cash so you can continually take advantage of changing market conditions.

As a rule of thumb, I like to find companies that pay 1/3 of their earnings through a dividend and the other 2/3 into the book value growth of the business (this is growth I don't pay taxes on).


Earnings 
----->  Option 1  ----->  Retained or Pay down debts ---->  Increase in Book Value or Equity
----->  Option 2 ------>  Dividends

Most companies retain some earnings (e.g. 2/3)  and also distribute some as dividends  (e.g. 1/3).



How can I employ Income Investing Techniques

Summary of this lesson

By employing the techniques of income investing, one can prepare themselves properly for retirement. Since income investing is the process of picking stable stocks and bonds that pay decent dividends and coupons, the investor can benefit from the cash flow that’s produced by these securities.

The first way income investing provides benefits to the investor is through liquidity. Since the investor will continually receive dividends or coupons, they then have the opportunity to reinvest that cash flow into the most undervalued asset each month. This compounding cash flow is truly the essence of investing like Warren Buffett. With an ever increasing cash flow, investors can take advantage of market conditions during spikes and valleys.

The second way income investing provides benefits to the investor is during retirement. Since most retirees may need to sell their investments in order to pay their monthly lifestyle expenses, income investing offers an alternative approach. Since the retiree will receive quarterly and semi annual payments from these types of investments, they will continue to have a steady cash flow to meet their lifestyle expenses. Although some retirees may need to pull from the principal, income investing will minimize that withdrawal.

In the end, Income Investing creates more cash flow for the individual employing the technique. It’s Warren Buffett’s opinion that purchasing dividend paying stocks is a very wise decision because of the continued and consistent cash flow that provides liquidity to reinvest your earnings.