Methodology

Stocks

Module 4

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Income investing

Income investing

As the name suggests, income investors are not concerned with the growth of their capital through rising stock prices. Instead, income investors are looking to boost their income through dividend payments.  

 

Income investing is usually associated with older people that have retired, as they are looking to boost their pension income. However, income investing can be used by people that have a lower-risk tolerance.

 

As income investing is less risky, the returns that an investor can expect are lower. When investing for income, investors can typically expect to earn an annual return of anything from 2% to 5%. With returns being low, income investors need to have a lot of cash in savings to make it a meaningful income stream. This is why it is suitable for retirees, as they often receive a lump sum as part of their pension.   

Income investing and risk

The stocks that offer the best opportunities for income are provided by established companies that are in the maturity phase of development. This is typically the case as mature companies have stable earnings but limited opportunities to grow the size of the company. Therefore, the best use of the money is to simply give it to investors.

 

Income stocks tend to have been listed on the stock market for a long time and have an average P/E ratio, when compared to other companies in their sector.  The most famous example of an income stock is Coca-Cola, which has been listed on the stock market for more than 100 years. The company offers shareholders a dividend of around 3% and has a P/E ratio of 29.64 (as of April 2022), which is slightly less than Pepsi at 31.38.

 

The risk of income investing is that the company becomes complacent and does not remain competitive in their sector, entering the decline phase. When a company enters the decline phase, the share price of the company will slowly decrease, removing any benefit of receiving the dividend. Such a risk can usually be identified by a large dividend % being offered by the stock of a company (i.e. 9%). This is usually a bad sign and suggests that the company is in trouble.

Income investing with growth

Instead of solely focusing on growth or income, many investors want to receive the benefits of both strategies. This is possible by investing in companies that focus on growing their dividend, while also increasing their stock price. Such stocks tend to offer a lower dividend, in order to have money on hand to invest in new projects. To some extent, Apple is a good example of an income stock with growth. Apple currently offer a very small dividend of 0.52% (as of April 2022), while continuing to invest in projects that will increase the share price of the company. This has worked well for Apple, with its stock price increasing by almost 400% in the last 5 years.

 

Investing in stocks that offer income and growth can benefit investors, allowing them to receive income and grow their capital. A general rule is that the higher a dividend payment is, the lower that an investor should expect in terms of growth of the stock price (and vice versa). This approach is generally more suitable for those with an average tolerance for risk.

 

It is important to note that both income and growth investing are long term strategies. By reinvesting dividends, an investor can benefit from compounding (i.e. earning interest on their interest), which can help them to build significant wealth over time.

What are income investors not concerned with?

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