As the name suggests, income stocks are those stocks which give their shareholders a regular source of income through payment of dividends. These dividends are paid regularly and often steadily increasing in amounts.
Do you hold such shares in your portfolio?
Well, if you don’t, it’s high time, you should! Let’s learn a bit more about such stocks.
The companies that are already large, mature and stable require lower amounts of capital investments due to which they have large reserves of cash. These more established companies that have already reached a certain size and are no longer able to sustain higher levels of growth and thus, use their reserves to pay dividends to their shareholders on a consistent basis.
Although it is also possible that large and stable companies may avoid paying dividends if they think that they have a better shot at increasing value and share prices by reinvesting their earnings.
This is for the simple reason that large and stable companies have lower chances of giving negative returns in comparison to young and smaller companies. Also, the volatility of these types of shares is very low as compared to growth and value stocks.
The basic fundamentals of a company should also be good in order to sustain growth. Dividends should not be the only reason to invest in a company.
Also, it is important to note that dividends should not be seen in terms of absolute numbers but in terms of dividend yield. The dividend yield of a stock is calculated by dividing yearly dividend payment by the current stock price:
Dividend Yield = Annual Dividends Per Share / Price Per Share
Income Stocks Example
For example, let’s say the stock price of a company is ₹300 per share. It offers an annual dividend of ₹30 per share. The dividend yield of the stock would be (30/300) X 100% = 10%.
Now, suppose that the same stock is trading at a lower price, say, ₹250 per share, the dividend yield will become 30/250 = 12%. Now, if the stock price is trading at a higher price, say, ₹350 per share, the dividend yield will become 30/350 = 8.57%.
This is the effect of the stock price on dividend yield.
As the stock price increases, the dividend yield decreases. A good dividend yield for Indian stocks is 2% – 6% annually. Income investors look for stocks with good dividend yields if the payment of high dividends is sustainable and can produce a steady and predictable income stream over the long term.
Generally, the companies that have a good track record of paying attractive dividends to their shareholders over the last 5 to 10 years, are likely to continue doing the same. They come in the category of income stocks. Paying high dividends on a consistent basis indicates the financial strength of a company because cash is needed in order to pay a dividend consistently over a long period of time.
Also, if the dividends are increasing over the last few years, it shows that the company has shown commendable growth in the past and is likely to deliver promising results in the future as well.
These are the reasons why investors who are retired and have less risk-taking capacities, prefer income stocks for their portfolios because companies that have been able to give good dividends to their shareholders consistently are more stable during bear markets as well.
In order to invest in income stocks, one should look at the stocks that have been giving the highest dividend yields and then, check the list of all those stocks to find fundamentally strong stocks that are safe to invest in. Only dividend yields do not say much about the company.
Therefore, it should be looked along with other factors like fundamentals of the company, the management of the company and future growth prospects of the sector etc.
There is no exact formula to identify an income stock but there are some things that can be considered while selecting stocks for one’s portfolio.
Some of these things have been discussed below –
Income Stocks With Dividends
Company’s annual reports can be referred to know about the kind of dividends it has been paying for the last 5 – 10 years.
One should also check if the company is making excessive payments through dividends which are decreasing the chances of the firm’s potential to make higher profits through reinvestment of that money into the company’s future growth. Also, a look at the dividend history also tells how likely is the company in making dividend payments in the upcoming years.
If the management is shareholder friendly, one may find a trend of increasing dividends especially in more mature and stable companies where the scope for further growth is limited.
Income Stocks – Positive Earnings
It is an important factor to check the financial health of the company. The company should have generated positive earnings with no losses every year for at least the past three years.
This is just to check the consistency of a company’s financial performance.
Income Stocks – High RoE
Return on Equity or Return on Net Worth (RoNW) measures the rate of return that the owners of common stock of a company receive on their shareholdings.
Return on Equity = Net Income or Profits After Tax / Shareholder’s Equity
The higher the return on net worth, the more efficient the company’s operations are making use of those funds. If the companies have a high return on equity and relatively less debt, they are doing considerably well as compared to their competitors.
Income Stocks – Company Debts
The company’s debt to equity ratio should be healthy in comparison with its peers in the same industry. Very high debts in the balance sheet of a company is a negative sign. The amount of debt raises the costs related to it and thus, the cash decreases as a result of it.
A company uses its cash in repayment of loans, pay dividends, capital expenditure, etc. Therefore, high debt costs can mean less cash available for dividends. Therefore, one should look for such companies that are actively working on decreasing their amounts of debt with every passing year.
Debt-free companies are relatively safer to invest in.
Income Stocks – Company Management
Management is one of the most important factors that have a huge impact on the overall performance of the company. Management has the potential to either make or break a company. Generally, income stocks belong to those companies whose management is excellent.
Well qualified and experienced promoters and management are able to handle all problems related to business efficiently and deliver good results consistently. Previous 5 years’ annual reports of companies should be seen to know about the management of the company.
They will tell whether the management is aware of the existing and potential problems of their business, how they are planning to solve those issues and whether they successfully delivered what they promised. All these things determine the quality of the management of a company.
Some of the best fundamentally strong companies in India which have been paying regular dividends to their shareholders are mentioned as follows:
Name of the Company
Dividend yield (in %)
1 Year Growth in sales in %
1 year Growth in PAT in %
Hindustan Petroleum Corp
Indian Oil Corporation
Oracle Fin. Services Software
Growth in the financial year ended March 31, 2017, as compared to the financial year ended March 31, 2016. Source – Ace Equity
Thus, we see that income stocks should be preferred if one wants a relatively less risky position in the stock market and a consistent stream of income coming through dividends.
If one selects stocks carefully by analysing the company’s fundamentals through balance sheet, profit and loss statement, cash flow statement and a comparison of financial ratios with peers of the same industry and comparison within the company over the last few years, a good increase in stock price over a period of time may doubly reward an income investor.
Other than financial aspects, investors should also keep an eye on the management of the company. Income stocks are the least risky kind of investment in the stock market and one must have at least some proportion of his/her investments in them even if the risk appetite is higher.
That is because diversification among different categories of stocks is the key to successful investing.
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