Using Income Investing As a Stock-Picking Strategy

Steady income is what most investors are after. However, due to low yields in the recent years, it has been tricky to create significant returns. Some securities have a fixed income, like bonds and CDs. However, income investors are looking for more opportunities. Thankfully, there are many dividend-paying stocks they can choose from.

Which companies pay dividends?

There are young companies that are looking to grow, and older, already established ones. However, only some of them may pay dividends if they want to.

There are three options they can choose from: pay dividends to their shareholders, reinvest the profit, or do both things at the same time. Younger companies tend to stay away from dividends because they want rapid growth.

In addition, even bigger, older companies also avoid dividends – Berkshire Hathaway, for example. Typically, companies that pay dividends are usually the ones that have stopped growing, having already left the rapidly advancing industries.

What is a dividend yield?

A dividend yield is the amount of the yearly dividend which shareholders can expect. The higher it is, the better the income. However, if the income is over 20%, it might be too risky to pursue.

For example, if ABC trades their stocks at $50 per share, they could also have an annual dividend of $5 per share. Therefore, their dividend yield would be 10%. But, if they trade the shares at a higher price, the dividend yield would be smaller.

In the real world, you can expect a dividend yield of about 2% to 5%, and it usually depends on the sector you are looking at. Many income investors try to find those that have higher yields, but they have to be careful. The dividend yield has to give them a steady income over many years to come.

 

Johnson & Johnson

A fantastic example of a company that paid dividends regularly is Johnson & Johnson. From 1963 up to 2004, they increased the yield every year. If you had bought a stock in 1963, that would mean the dividend yield would have grown at least 12% every year.

After 30 years, you would have a 48% annual return for those same shares you bought in 1963.

However, if you want such results, you would have to do some proper research. Finding a good income investing stock is not for the faint-hearted. Before you decide on one, try using a stock screener to find out which company has the highest dividend yield. After that, you could use fundamental analysis for further research.

Don’t rely solely on dividends

Just like other strategies, this one also doesn’t have a “one size fits all” formula. Finding a fantastic company that gives high dividends is not easy – and it can also be risky.

Just because the dividend yield is high, it doesn’t mean that it is a good company. After all, those dividends are coming from the company’s income. Furthermore, sometimes it is better to reinvest and enhance the growth than pay out high dividends.

In addition, you cannot rely just on a stock scanner for this purpose. You would need to have proper knowledge about income investing so that you could reach the right decision. Apart from that, your personal judgment plays a part too.

Dividends can also be risky

If you thought that this would be easier and that you could lower the risk, but still make an income – think again. Any risk that we can connect to equity security is the same as the one we can apply to high dividend yields. However, you can avoid problems by picking solid, established companies.

You cannot avoid taxes

Another important thing to remember is that, in most countries, dividends are taxed just like your wages. In addition to that, you would have to pay a higher tax bill for them than for capital gains. Therefore, this might actually lower your return significantly.

 

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