Analysing Income Stocks

People choose to purchase income stocks because they are looking for a source of immediate income and also a long term source of income.

So if you are planning on investing for your retirement which is 10 or 20 years away, then income stocks may not be the right choice for you.

Rather, you would probably be better off investing in growth stocks because they are more likely to grow your money faster than you could with income stocks.

Yield

Income stocks pay out dividends. Therefore, when selecting income stocks as a stock market investor, you need to decide which stocks will give you highest income if you are to make the best investment decision.

When analysing stocks, the main thing you need to look for is yield. This is the percentage rate of return paid on a stock in the form of dividends.

Once you know the stocks dividend yield, you will quickly be able to see how much money you will make from a particular income stock versus other dividend paying stocks.

Calculating dividend yield is simple. You just divide dividend income by your stock investment.

Examining Stock Yield

Dividend yield is provided along with a stock’s price and annual dividend in the financial pages.

The dividend yield is calculated as if you had bought the stock on that day, and because of changes in supply and demand in the stock market, stock prices will fluctuate from day to day which will cause dividend yield to fluctuate.

Due to these variations in the stock market and prices in stocks, keep in mind the following two points when examining yield.

1 – What Yield Are You Receiving?

If the price of a stock changes so will its dividend yield. For example, you bought a stock last month for $20 per share and your yield was 5%. Now that stock is selling for $40 a share and the yield quoted in the financial pages is 2.5%.

At first glance it may appear as though your dividend got cut in half. However, this is not the case because you bought the stock at $20 and the yield being quoted now is for the current stock price at $40.

So even though this stock may have been a good purchase for you in the past, today, it is not such a good deal because the rise in stock price has been accompanied by a reduction in yield.

2 – Stock Market Price

Another way to look at yield is by the amount of money you have invested. For example, you purchased 100 shares at $20 and paid $2000 for them, but later those stocks increase in value to $40 and they cost you $4000.

Now, assuming the total dividend income you get from them is the same, from a yield perspective, the $2000 investment would yield you more because you are getting this income with a smaller investment.

Stock’s Payout Ratio

A stock’s payout ratio can be used as a measure of what percentage a company’s earnings are being paid out in the form of dividends.

Since a company will pay dividends from their net earnings, these should always be higher than the dividends a company pays out. This payout ratio can be calculated by dividing the dividend per share by the earnings per share.

A good payout ratio is between 50-70 percent, because even if a company’s earnings fall by 10 or 20 percent, they will still be able to pay out dividends.

A payout ratio higher than this is considered to be dangerous, because if that company experiences any financial difficulties it may not be able to pay out its dividends. So the lower the payout ratio, the safer the dividend.