Income Investing: It’s a good strategy but here are 4 factors you should consider

Income investing in relation to stocks involves generating returns from stocks via dividends, rather than share price appreciation.

Dividends are regular payments made by companies to their shareholders. They are usually paid quarterly, but can also be paid monthly or annually. However, not all companies pay dividends. So, how do you determine if your stock will pay a dividend?

In this article, we outline 4 things to look for.

4 things to look for when income investing

1. Check the company’s dividend history:

One of the best ways to determine whether a company will pay a dividend is to look at its dividend history. A company that has a long history of paying dividends is more likely to continue doing so in the future.

A company that has never paid one before, however, might one day although it will be difficult to tell just when it will happen. You can easily find this information on the company’s website or on financial websites like Yahoo! Finance or Market Index.

2. Look at the company’s financial health

If a company is in good financial health, it is more likely to pay a dividend. Check the company’s balance sheet, income statement, and cash flow statement to see how it is performing financially. A company with a strong balance sheet, steady income, and positive cash flow is more likely to be able to pay a dividend.

Of course, there is a risk that a company looking good may suddenly confess that things have taken a turn for the worse. In fact, there’s a term ‘Confession Season’ for the period of the year when many companies do this! The reason it is such a shock is that investors were expecting the company to do better than it will have then revealed itself to perform.

3. Consider the industry

Different industries have different dividend policies. For example, utility companies and real estate investment trusts (REITs) usually pay higher dividends than technology companies. This is because utility companies and REITs are considered to be stable, cash-generating businesses – indeed, the sole purpose of REITs is to pay distributions.

Companies in sectors as technology, however, are going for growth and reinvesting surplus cash is better than paying out dividends to investors, even if they could afford to make pay outs. So you shouldn’t be buying these companies to receive dividends, but should be pleasantly surprised if you do. This may be different for larger, well-established technology companies, however.

4. Look at the payout ratio

The payout ratio is the percentage of a company’s earnings that are paid out as dividends. A high payout ratio can indicate that a company is committed to paying dividends, but it can also be a sign that the company is struggling financially. A low payout ratio can indicate that a company is retaining earnings to reinvest in the business or pay down debt.

As a general rule, a payout ratio below 50% should be considered low whilst a ratio above 80% should be considered high. Nonetheless, a company with a spectacular result that is a one-off might well maintain dividends to ensure it has some slack in the balance sheet.

Dividends shouldn’t be the only factor for income investors to consider

In conclusion, there are several factors for income investors to consider when determining whether a stock will pay a dividend. These include a company’s dividend history, financial health, industry, and payout ratio. By analysing these factors (and others), investors can make a more informed decision about whether to invest in a dividend-paying stock.

Granted, past performance is not always a reliable indicator of future performance – otherwise there would be no such thing as ‘Confession Season’. And remember, dividends should not be the only factor investors should consider when making an investment decision. Nonetheless, they are an important component of a well-rounded investment strategy.

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