Lots of investors spend their lives looking for the holy grail of investing – a portfolio of high income shares.
Working out which companies fit the bill by offering the potential for paying high dividends over a long period is never easy.
Picking the right stock takes a lot more work than reading the latest picks and tips.
Instead, investors should consider numbers from the accounts and analyse finances, a company’s business model and where it sits in the trading cycle.
The rule of thumb is a company that can easily afford to pay a handsome dividend now is likely to have the resources to continue to do so.
But… and there is always a but… some companies pay too much too soon and may have to cut back.
Backing a winner
The trick is spotting which category a company falls into and backing the winner instead of the loser.
The professional tool for the analysis is the dividend pay-out ratio.
Calculate the number by dividing dividends paid by total earnings as a percentage. The warning sign is a company paying a ratio of more than 100%.
Directors doing this are paying more in dividends than they are making in profits.
In general, the lower the ratio, the better the prospect of long-term income.
Next, carefully study the business model. A stable business in utilities or tobacco is more likely to consistently pay dividends. Watch for business that are cyclical or slaves to economic performance.
Selection rules
Where the company sits in the business cycle is also worth considering. Start-ups may look attractive investments but are unlikely to pay dividends as they need to reinvest profits to grow, but mature companies with less stress on funding growth from profits are good bets to generate high incomes.
Other financials to look at would include gearing, diversification and market capitalisation. Companies outside the FTSE250 are more likely reinvesting profits in growth than rewarding investors.
The aim is to select between 15 and 20 high income shares for a portfolio.
Don’t forget to keep a watchful eye on the portfolio – selection rules applying when the share was picked but the stock can fail to perform because of changes within the market or business.
