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What is an income stock?
What are the important things that you should know?
In this article, I will break down the notion of Income Stock so you know all there is to know about it!
Keep reading as I have gathered exactly the information that you need!
Let’s define income stocks, look at examples, and see how they work!
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What Is Income Stock
An income stock is a phrase used to refer to shares of stock that are expected to pay dividends to its shareholders.
When you buy an “income stock”, you are essentially buying shares of stock in a company that regularly issues dividends.
Typically, income stocks are mature companies that are well-established, profitable, and have enough capital to reinvest in their business but also reward their shareholders with dividends.
Well-established and profitable companies are generally referred to as “blue chip stocks” having stable earnings and a solid financial position.
In most cases, dividend stocks tend to have a lower investment risk as a result of the return that you get over the course of your stock ownership.
Not all dividend stocks are necessarily low risk as some companies provide a high dividend income to attract investors but you’ll need to assess whether the company is in a healthy financial position or not.
Overall, income stocks will have less price volatility than non-income stocks, should offer you a dividend yield above low-risk debt securities such as Treasury bills, and provide a moderate level of capital appreciation over time.
To better understand income stocks, let’s further break down the phrase into its components, “income” and “stock”.
What Is Stock
A stock refers to units of ownership in a company.
When you buy stocks in a company, you become a shareholder in the company or a part-owner.
As you stockholder, you will have the right to vote in the company’s annual meeting to elect the members of the board, you generally will have the right to receive dividends, and you may be entitled to receive liquidation proceeds if the company is wound down.
Investors invest in the stock market and buy stocks in different companies as they are hoping to see the stock price appreciate in time (for capital gains) or to receive some income in the course of the stock ownership (dividends).
What Is Income
In the stock market, when you talk about income, you are talking about dividends.
There are two major types of stocks that you can purchase regardless of industry or sector in relation to income: income stocks or non-income stocks or non-dividend stocks.
If you buy income stocks, you are attracted by the company’s steady and continuous distribution of its profits to its shareholders in the form of dividends.
If you buy stocks that do not pay dividends, you are attracted by characteristics other than the receipt of dividends from time to time.
Generally, investing in non-income stocks, you may be looking for growth, perhaps you’re looking to diversify your portfolio, or you may have another strategy in mind.
Income Stock Definition
According to Investopedia, income stock is defined as follows:
An income stock is a security that pays regular, often steadily increasing, dividends.
In other words, an “income” stock refers to shares of stock that you can buy providing you with an income (dividends).
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Income Stock Characteristics
What are the characteristics of income stocks?
In many cases, stocks producing an income have the following characteristics:
- The dividend yield may provide the majority of the stock’s overall return
- Their stock price is less volatile than non-dividend securities
- The stock price may not appreciate as much over time
Since dividend securities provide investors with regular cash flow, conservative investors tend to like such investments as they can get back parts of their investment over time.
Investing in dividend-paying stocks is a great way to generate consistent revenue but also has the potential for some capital gains over the stock price if the investment is held long enough.
Although you can find companies paying dividends in many industries and sectors, here are the industries where you tend to find many companies paying dividends:
- Real estate (such as real estate investment trusts)
- Natural resources
- Financial institutions (such as banks)
If you are looking to invest in revenue stocks, you should look for companies that are financially sound, have a good history of steady growth over time, have been consistently paying dividends, and have low stock volatility.
In summary, the following represents the key features of income stocks:
- Distribution of profits in the form of dividends
- Most dividends are paid in cash distributions
- The stock carries lower levels of risk
- The stock price may offer lower price appreciation
- The stock price will be less subject to volatility
- There may be some sensitivity to interest rate changes
Income Stock vs Growth Stock
What is the difference between income stock and growth stock?
An income stock is a type of security that offers its shareholders regular cash flows paid in the form of dividends.
Income stocks tend to have lower price volatility and represent a safer investment then other types of stocks.
In many cases, conservative investors may opt for income securities as they have the comfort that their investment carries less risk than other types of equity securities, they can expect to receive some revenues over time, and they can even see some appreciation in the stock price over time.
On the other hand, a growth stock is a type of security that does not pay dividends.
Companies that are considered as “growth stocks” are those where their management prefers to retain all their profits to be reinvested in the business to create more value.
As a result, even though the growth stock may produce profits, they do not distribute the profits to the shareholders so they can further fund the business.
Investors buying into growth stocks are relying on the fact that the company will effectively generate more revenues in time resulting in a more significant appreciation in the value of the stock price.
Growth stocks are riskier in nature and provide a return on investment strictly in the form of capital gains (you sell the stock for a price higher than what you paid for it).
Another factor to consider is the price volatility of growth stocks.
Unlike income stocks, growth stocks are prone to price volatility with the slightest change in the market confidence in the company’s ability to grow and generate positive returns over time.
If there’s bad news about the company, market conditions change, industry conditions change, company’s financial reports are disappointing, these are all factors that may result in a sharp decline in the stock price.
If you’re investing in growth stocks, you must be ready to live with such price fluctuations and perhaps keep your investment long enough to allow the company to effectively grow with time.
Income Stock Examples
What are some examples of income stocks?
There are some companies that have been paying dividends consistently for a long time making them dividend aristocrats.
Just to give you an example of one dividend aristocrat, the company Exxon Mobil Corporation (XOM), in the oil and gas sector, has been paying dividends since 1882.
Other good examples of companies paying dividends are The Coca-Cola Company, Proctor & Gamble Co., Eli Lilly and Co, Chubb Corp, and Walmart Inc.
As you can see, most of these companies are brand names that many households in the United States recognize (and even around the world).
Now, let’s look at a hypothetical example of how dividend payments work and the yield an investor may achieve.
Imagine you like to invest in a company with its shares trading at $50.00 per share.
The company regularly pays dividends four times a year (every quarter) by paying $0.50 per share every quarter.
This means that you can expect to receive $2.00 of dividends from the company every year.
To calculate your dividend yield, you take $2.00 (your expected yearly dividend) and divided it by the stock price ($50.00) and you get 4%.
In other words, by investing $50 to purchase one share of stock, you can expect to receive a 4% return on your investment every year.
If you compare your 4% return to the 10-year Treasury bills in the market, you can tell whether you are getting a good yield or not.
If the 10-year T-Bill is offering 2% return to its investors, you are making two times the return compared to a risk-free investment.
However, if you are below the return of a 10-year treasury note, you are actually earning less than putting your money in a risk-free investment (so you should reconsider your investment to make sure you are investing as per your strategy).
Income Investing Strategy
A great investment strategy to adopt is the income investing strategy.
In other words, with an income-focused investment strategy, your objective is to purchase dividend-paying stocks that you can expect to receive a reliable return over time.
You can diversify your dividend stocks by purchasing stocks in different companies, different sectors, or different markets.
You can also consider purchasing mutual funds or exchange-traded funds (ETFs) having a focus on dividend-paying stocks.
If you have a good portfolio of “income stocks”, you can better mitigate your risk in case one or a few companies you own stop paying dividends.
In addition to that, you can also invest in market sectors that can provide you with more or less risk (depending on your risk tolerance) so you are less impacted by shifts in the overall market conditions.
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Income Stocks Takeaways
So, there you have it folks!
Looking to define income stock?
Well, in this article, I have broken down the meaning of income producing stocks so you know all there is to know about it.
I’ve looked at what are the characteristics of income stock, what is the difference between income stock and growth stock, what are examples of income stocks, and more.
Income stocks are those stocks that you can reliably expect to pay dividends to its shareholders.
Typically, profitable companies may choose to distribute a portion of their profits to their shareholders in the form of dividends.
When a company pays dividends to its shareholders on a monthly, quarterly, semi-annually, or annually, you can say that the company is an income stock.
Well-established corporations with steady profits are able to continuously pay dividends to their shareholders rewarding them for owning their stocks.
For that reason, many conservative investors like investing in dividend stocks because they can invest in a relatively safe business, expect to receive some cash flows, and potentially sell for a decent profit.
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What Is Income Stocks
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