Income Stocks: A Guide to Dividend Investing

Income stocks are equity financial securities that pay regular and predictable dividendsDividendA dividend is a share of profits and retained earnings that a company pays out to its shareholders. When a company generates a profit and accumulates retained earnings, those earnings can be either reinvested in the business or paid out to shareholders as a dividend.. They are purchased with the purpose of generating a steady stream of dividend flows.

In addition, investors hope that the dividend flows will increase over time. Income stocks are typically derived from the real estate, energy, or utilities industries. Though the stocks can be derived from any industry, they are typically found in the ones above.

Uses of Income Stocks

Income stocks can be used by investors with a low risk-reward preference as income stocks are typically more stable and less volatile. Retirees or an older demographic of investors may be attracted to income stocks since they are generally more stable and provide a steady stream of dividends.

In addition to an older demographic or retirees, another use of income stocks can be investments by a pension planPension FundA pension fund is a fund that accumulates capital to be paid out as a pension for employees when they retire at the end of their careers.. Since pension plans typically invest in safer investments and need to pay out to those who qualify to withdraw from their pensions, income stocks are a suitable choice.

Also, income stocks can also be used to match revenue streams with future cash outflows. Insurance companies typically invest in fixed-income securities, which generate periodic revenue streams that are applied to claims made throughout a year.

Types of Industries

Though income stocks can arise from any industry, they are commonly found in the real estate, energy, and utility industries. An example of such stocks from the real estate industry is real estate investment trusts (REITs)Real Estate Investment Trust (REIT)A real estate investment trust (REIT) is an investment fund or security that invests in income-generating real estate properties. The fund is operated and owned by a company of shareholders who contribute money to invest in commercial properties, such as office and apartment buildings, warehouses, hospitals, shopping centers, student housing, hotels.

REITs package the rental and lease flows of residential or commercial properties and put them into a security that can be traded like a stock. For example, the rents that tenants of an apartment building pay every month can be packaged into an equity REIT and traded like a stock. The stock would be considered an income stock as it generates a monthly inflow of rental income, which can be paid out as dividends to shareholders.

With regard to the energy industry, many midstream oil and gas companies are structured as master limited partnerships (MLPs)Master Limited PartnershipA master limited partnership is a publicly-traded business venture that combines the features of a corporation with that of a partnership and exists as. MLPs pay out cash disbursements to investors and may also offer tax advantages in relation to regular dividends.

The utility industry is also a common source for income stocks. Utility companies are typically faced with an inelastic demand as the goor or service they provide is almost always a necessity (water, electricity, etc.). Thus, the utility companies’ revenues and dividends are not as volatile as the stocks from other industries.

It is important to note that the nature of the industry and business models significantly affects whether or not a certain stock will provide steady, regular, and sometimes increasing dividends.

Income Stocks vs. Value Stocks vs. Growth Stocks

As discussed above, income stocks are stocks that pay regular and stable dividends to investors. In contrast, value stocksValue StocksValue stocks are stocks that are currently trading at a price lower than their actual intrinsic price. It basically means that the stocks are undervalued, are stocks that are perceived to be undervalued relative to their performance. Value stock investors invest to take advantage of the market’s perceived mispricing of the stock.

Many metrics, indicators, or methods can be used to analyze whether a stock is a value stock and is underpriced; examples are a financial model using a discounted cash flow analysis or a comparable analysis.

Growth stocks are stocks that come with a very high potential for future growth. A classic example of a growth stock would be Amazon. Investors who are seeking growth stock opportunities and significant returns will typically gravitate towards growth stocks; however, it is important to note that with the high potential for growth also comes a higher amount of risk.

Income, value, and growth stocks all vary significantly in their risk-reward characteristics and thus attract different kinds of investors with different goals.

Income Stocks and Mortgage-Backed Securities

Mortgage-backed securities are bonds secured by home loans or other real estate loans. REIT income stocks are somewhat similar to mortgage-backed securities in the sense that they both package real estate assets and their respective flows. However, mortgage-backed securities typically act as a fixed income security and thus may be a less risky investment.

More Resources

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