Here’s how to invest in income stocks
Many investors who want their funds to generate a steady stream of returns put their money into fixed-income securities, commonly known as bonds. This approach is commonly adopted by retirees or even younger people who are looking to establish an additional revenue stream for themselves.
But an individual whose investment focus is income generation has other options too. Stocks of some companies provide regular dividends, giving investors in this category a viable alternative. Investing in a company has other advantages as well.
There is the possibility of capital appreciation if market conditions improve or if the company increases its revenues and profitability. Investors could also benefit from higher dividends over a period of time.
Of course, there is a risk as well. Poor management or a slowdown in the industry in which the company operates may lead to a fall in share price and a reduction in the dividend payout.
How can you identify stocks that fit into your income investment strategy? Source: Shutterstock[/caption]
Obviously, you should look for companies that have a consistent dividend-paying record. But the regularity with which dividends are paid or even the absolute amount of the dividend that is paid are not the only factors that you should consider.
The critical metric to look at is the dividend yield. This is a financial ratio that is calculated by dividing the actual dividend paid in a year by the company’s current share price. A higher ratio can indicate an investment option that will help you meet your goal of maximising your income.
But don’t make the mistake of considering this financial ratio in isolation. Consider the example of Singapore Airlines, a company which features on the “25 SGX-Listed Stocks in the FTSE All-World High Dividend Yield Index” page of the Singapore Exchange.
Singapore Airlines provided a dividend yield of 4.5% in 2016, which, although not very high, is a respectable ratio for a well-established company with tremendous potential. But the total return that it gave its shareholders in 2016 was -10%.
The company registered a negative return because of a fall in its share value in the last year. Focusing only on dividend yield is an incorrect way of identifying an “income stock.”
Attributes of an “income stock”
Stock market volatility can lead to a fall in share prices, making it difficult to pick stocks that will provide a high dividend yield as well as a capital gain. Despite this constraint, investors should look for the following traits in a company in their quest for “income stocks.”
- The company should have been established many years ago and be at a stage where it is not growing rapidly. Fast-growing firms require large amounts of capital to finance their growth. They are unlikely to pay high dividends.
- Capital investment requirements should be low. The company should have already established its infrastructure. Additional funds should be required only for repairs and for the upkeep of existing facilities.
- The company should have limited options to deploy its capital. A mature firm that is highly profitable and which has a limited capital expenditure budget would make an ideal choice.
Although there is no specific formula to identify an “income stock”, high dividend yield companies are normally found in certain industries. Many utility companies fall into this category, as do telecom companies and firms dealing in consumer staples.
Some high dividend yield stocks on the Singapore Exchange
The following is a table of some prominent SGX companies. The data presented illustrates that while a company may give a reasonable dividend yield, the overall return that it gives its shareholders may be negative.
Conversely, companies may have low dividend yields, but significantly higher total returns.
Table 1 Reasonable dividend yield, but negative total returns
Market Cap S$Bln
Singapore Press Holdings
Hutchison Port Hldgs Trust
Table 2 Low dividend yield, but high total return
Market Cap S$Bln
Your income investment strategy should not be dependent entirely on bonds
While bonds offer steady returns and appear less risky, they should not form your entire income investment portfolio. It is essential to incorporate high dividend yield stocks into your strategy as well, even though you run the risk of encountering market volatility. By doing this, it is quite possible that you will register some capital gains as well.
But remember to restrict your investment to stocks in mature companies that have a record of consistently paying dividends over the years.