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Wouldn't it be nice to earn income in addition to the capital appreciation on your investment? Income stocks appreciate like other stocks, but they also pay a relatively large dividend. It is helpful to compare an income stock investment with a conservative investment in Treasury bonds or a savings account where capital appreciation is impossible but income is guaranteed. For example, if you put $1,000 in the bank at 4% interest, you will get $40 interest annually, but the original $1,000 is unchanged. Income stocks might pay similar dividends but potentially provide capital gain on top of the dividends if the share price rises. As with all stock investments, however, income or gains are not guaranteed.
An important term when investing in income stocks is "yield", which is the percentage of the share price that a company pays in dividends annually. To calculate the yield, take the dividend amount you will receive for the year divided by the share price of the company. For example, if Disney pays a $0.25 dividend quarterly, you will receive $1 in dividend annually. If Disney is trading at $40, the yield would be 1/40, or 2.5%. If the share price drops to $20, the yield would be 1/20, or 5%. In other words, if the annual dividend remains constant and the share price decreases, the yield will increase.
High income stocks, or those paying high dividends, are usually the utility stocks or Real Estate Investment Trust (REIT). Traditionally, REITs have high cash flow from real estate rental, which they distribute to shareholders quarterly as dividends. Utilities and REITs usually have yields between 5% and 10%. When buying income stocks, shareholders could make money from the quarterly dividends as well from as an increase in share price. But if the company loses money, it could stop paying dividends.
One strategy for buying income stocks is investing in large-cap, high-yielding stocks. An easy way to pick these stocks is using a method called Dogs of the Dow. It involves buying the ten Dow stocks with high yields and good dividends because the share price is having a temporary setback. If the company resumes upward growth, investors will profit. By looking at the historical data and investing in Dogs of the Dow, investors can get a better return and higher yield on their investment.