Investing in Income Stocks

Investors tend to fall into two camps. One group -- usually younger investors with many years until retirement -- wants to build its wealth by investing in growth stocks. The other -- mainly those near or in retirement -- seeks to generate money passively from income stocks, in order to pay for some of their expenses.

This handy guide helps that latter group of investors to learn which are the best income stocks to buy and to understand how to create an income stocks investing strategy.

What are income stocks? 

An income stock is one that reliably pays a dividend to its shareholders. Dividend payments are typically disbursed in cash that companies send to their investors regularly. Most companies pay quarterly dividends, though some pay only annually or semi-annually, while a handful pay dividends each month. Dividends are paid as a portion of a business's profits.

Unlike growth stocks, which investors buy primarily because they expect the stocks' values to increase, income stocks are attractive to investors who want to earn short-term yields on their investments. You can calculate a stock's dividend yield by dividing its total annual dividend payments by its stock price. For example, consider a stock that pays a quarterly dividend of $0.25 and produces $1.00 in annual payments. If that stock is trading for $20 per share, then its dividend yield is five percent.

Best income stocks

The best income stocks have increasing cash payouts over time; investors who buy these stocks enjoy income streams that grow steadily higher. A stock whose dividend increases by 10% annually doubles its cash payout to shareholders in little more than seven years, while a stock whose dividend rises by 15% annually doubles its cash payout in just five years. Dividend growth tends to drive a stock's price higher, as investors are typically willing to pay more for stocks offering rising cash payouts.

• Waste Management (NYSE:WM) excels at turning trash into cash for its investors. The aptly named provider of waste collection, disposal, and recycling services is the largest such company in North America. Its vast network of existing landfills forms a robust economic moat around its business, as strict regulations and rigid homeowner opposition to new landfills make it unlikely that competitors will be able to wrest market share from the garbage king. Waste Management's profits are well protected, and it passes much of its free cash flow on to investors. Its steadily growing dividend yields approximately two percent currently. In fact, Waste Management has increased its dividend payout for 18 consecutive years, and investors who buy shares today can expect many more dividend increases in the years ahead.
• Verizon Communications (NYSE:VZ) is another excellent income stock. The telecommunications titan is widely regarded as having the best wireless network in the U.S., which it uses to serve approximately 120 million wireless customers. Verizon has earned its customers' loyalty, as shown by its industry-leading retention rates. Its wireless subscribers provide a reliable base of revenue and cash flow, which is how Verizon generated a staggering $23.6 billion in free cash flow in 2020. This much available cash enabled the company last year to reward its shareholders with more than $10 billion in dividends. Verizon's shares currently yield a hefty dividend of 4.6%. Better still, the telecom giant has increased its dividend for 14 straight years, meaning that Verizon's investors can expect their cash payouts to keep growing steadily over time.
• Microsoft (NASDAQ:MSFT) is an outstanding dividend-paying stock. The technology industry leader reliably generates revenue in several ways, which is a boon for its income investors. Its Windows computer operating system continues to produce sizable profits, and its massively popular Office suite of productivity software is enjoying renewed growth, thanks to the product's transition to a cloud-based delivery model. Microsoft's Azure cloud infrastructure business is expanding at a brisk clip, and LinkedIn, which Microsoft owns, is growing rapidly. Along with its popular gaming platform Xbox, the company's revenue will likely continue to grow in the coming years. Microsoft's current dividend yield, while somewhat modest at roughly one percent, is increasing quickly. The company boosted its dividend by 11% in 2020, the 18th consecutive year that it's raised its payout.

How to create an income investing strategy

One way to create an income investing strategy is to establish a portfolio of stocks based on their abilities to earn dividend income from the stock market. The stocks mentioned above are three great alternatives with which to get started. You can also purchase a mutual fund or exchange-traded fund (ETF) that is concentrated in dividend-paying stocks. The objective of any income investing strategy is to benefit from a diversified selection of income-generating stocks, as doing so can offset the impact to your portfolio from any one company reducing or suspending its dividend, whether due to market conditions or financial struggles or both.