Topic: Dividend Stocks

How to find a good income stock for your portfolio

December 20, 2016|by Pat McKeough

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If you’re looking for a top income stock, look for an investment that has consistently paid dividends

An income stock usually has two distinct traits: A high dividend yield and a history of paying (and raising) their dividends. For a true measure of stability, focus on those companies that have maintained or raised their dividends during economic downturns or recessions.

You can identify income stocks by their high dividend yields. For example, stocks with a dividend yield higher than, say, 3% would typically be attractive to an income-seeking investor.

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Why you may want to invest in an income stock

Even if you don’t need current income from your portfolio, you still may want to invest in income stocks. When you pick the best income stocks, you are, for the most part, investing in safer and more secure companies. That’s in large part because of the dividends that the best income stocks pay. Dividends, after all, are much more stable than earnings projections. More important, dividends are impossible to fake—either the company has the cash to pay dividends or it doesn’t.

At the same time, it’s important to avoid judging a company based solely on its dividend yield. That’s because a high yield can sometimes be a danger sign rather than a bargain. For example, a company’s dividend yield could be high simply because its share price has dropped sharply (because you use a company’s share price to calculate yield). That can be a sign of an imminent dividend cut.

Factors for finding a high-quality income stock

a) Financial factors: Start your search by looking for companies that have a 5- to 10-year history of profits. Companies that make money regularly are safer than chronic or even occasional money losers. You’ll also want to look mostly for companies that have been paying dividends for at least 5 years—10 years is even better. Companies can fake earnings, but dividends are cash outlays. If you only buy dividend-paying value stock picks, you’ll avoid most frauds. The last financial measure we like to see in a company is manageable debt. When bad times hit, debt-heavy companies often go broke first.

Canada’s big-five banks are among the best income stocks for investors Read More >>

b) Safety factors: Picking the best income stocks means picking stocks that have a degree of safety built into them. We look for companies that have industry prominence if not dominance. Major companies can influence legislation, industry trends and other business factors to suit themselves. Smaller firms, on the other hand, don’t have that ability.

The next safety factor we look at is geographical diversification. We like strong companies that operate Canada-wide, but we think multinational corporations are better. There’s extra risk in firms confined to one small geographical area. The last safety factor we consider is that the best income stocks must be free of excess regulation, free of dependence on a single customer, and free from self-dealing insiders or parent companies.

c) Survival/growth factors: We feel that the best income stocks are the ones that are free from business cycles. Demand periodically dries up in “cyclical” businesses, such as resources and manufacturing. You can hold some of these stocks in your portfolio, but keep them to a reasonable part of a well-balanced portfolio.

We are also particularly keen on companies who have ownership of strong brand names and an impeccable reputation. Customers keep coming back to these businesses, and will in turn try their new products.

It may be hard to find companies that have all of these factors, but we feel the best income stocks have many of them.

Want a great income stock? Look in the Utilities and Canadian Financial sector

While we continue to recommend that you spread your investments out across the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; and Utilities), the proportion of your holdings you devote to each sector depends on your temperament and financial goals.

For example, if you’re an income investor, you may wish to place more emphasis on Utilities and Canadian banks. That’s because these firms generally pay high, secure dividends, and have long histories of raising their payments, even during downturns. However, you’ll still want to make sure your portfolio is well-diversified across most if not all of the sectors. 

By diversifying across most if not all of the five sectors, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or investor fashion.

You also increase your chances of stumbling upon a market superstar—a stock that does two to three or more times better than the market average.

Do you have an income stock in your portfolio? How about multiple income stocks? Share your story with us in the comments.