One of the most basic stock-picking strategies is income investing.  With this style, you look to pick companies that will provide you with a steady income.  The most popular strategy among income investors is building a portfolio with stocks that pay out dividends. 

Starting with dividends

Companies that pay dividends tend to be older, established firms.  Most of these have more or less maxed out their size potential and are mature companies with slower growth rate.  Instead of reinvesting their earnings, these “cash cows” pay them out to shareholders.  You tend to find these types of companies in certain industries, such as utility companies and many consumer goods companies.

Utilizing the dividend yield

Income investing means more than picking the company that pays the most dollars.  Instead, you have to look at the dividend yield.  This number is the annual dividend per share by share price, or the actual return that a dividend will give you.  The average yield is 2-3%, thus, you should find companies that offer a higher yield, usually in the neighborhood of 5-6%.  That means if you were to invest $1 million, you would receive $50,000-$60,000 in dividends before taxes. However, be cautioned that companies offering exorbitant dividends may present a higher risk than lower paying firms.

Reviewing the financial history

You will also want to look at the dividend policy that a company has had in the past.  This will give you an idea as to whether or not the company will continue to produce dividends at its current level.  A dramatic increase in a short amount of time may be unsustainable, but companies that have had steady dividends for several years will likely continue to do so.

Many companies will pay dividends and continue to grow.  If you invested in stock in Johnson & Johnson in 1963, for example, in thirty years you would have received a 48% annual return on your initial shares considering actual dividends and the growth in the stock’s price.  This shows you the dramatic earning potential that income investing can have when done properly.

Analyzing other financial factors

The yields from your choice of stock are only good to your portfolio if they are sustainable and can continue producing.  This means that you have to choose carefully based upon your research and analysis.  There is no set formula for finding the right company for income investing.  You have to use your own judgment and deductive skills to choose what companies will work best for your portfolio.

You also need to keep in mind that just because a company pays dividends does not mean that it will have less risk to you.  You will still have the same amount of risk as with any equity security.  However, you can lower your risk level by looking for good, stable companies with a continued growth pattern over the long term.

Lastly, you will need to factor taxes into your equation.  In most places, the dividend payments you receive will be taxed the same at the same rates as your regular wages, without the benefit of taxes being withheld. Taxes will, therefore, not only reduce your overall return amount but may present themselves at tax time in the form of a bill to Uncle Sam; so save accordingly.