An income investment company is an asset management firm focused on generating income for its clients, often through a portfolio that emphasizes income-generating securities. Income-generating securities are primarily those that pay out dividends or regular income streams, such as bonds, and are chosen because of this feature as opposed to securities that are considered growth securities, whose price will appreciate.
Income-generating securities include bonds, preferred shares, fixed-rate capital structures, and dividends. Capital appreciation is not a focus but is preferred.
Stocks with a history of steadily increasing dividend ratios are particularly attractive to income investment companies.
Dividend yield and the relative growth of dividend per share (DPS) to earnings per share (EPS) are two key metrics that an income investment company uses to value a specific security prior to adding it to the portfolio.
Dividends are taxed at the ordinary income tax bracket of the investor, unless the dividend is considered to be a qualified dividend where it will then be taxed at the more favorable capital gains tax rate.
To invest in income investment companies, investors can choose among mutual funds, exchange-traded funds (ETFs), real estate investment trusts (REITs), business development companies (BDCs), and master limited partnerships (MLPs).
Essentially, an income investment company is a management firm whose aim is to build wealth for its clients. Their portfolios are, typically, structured to feature bonds, preferred shares, fixed-rate capital structures, and dividends.
The goal is to generate a steady flow of income for investors rather than to maximize gains to the portfolio’s value, though capital appreciation is also desired. Stocks with a history of steadily increasing dividend ratios are particularly attractive to income investment companies.
Income from securities inherently lowers the risk for investors, as the income mitigates losses to the value of the holdings. Further, companies that pay dividends tend to be stable, having weathered down markets in the past.
These companies have less room for growth but are less likely to suffer extreme losses. Though it’s counterintuitive, the income investment company may reinvest dividends and bond coupons rather than distribute them among fund investors.
When choosing an income investment company, investors have a variety of investment vehicles to choose from. Options include mutual funds, exchange-traded funds (ETFs), real estate investment trusts (REITs), business development companies (BDCs), and master limited partnerships (MLPs).
Investors interested in pursuing income investing should familiarize themselves with the metrics investment companies look at when evaluating income-generating stocks. The most obvious way to measure dividend payments, in actual dollars, is not the best way to judge the value of the stock to an income portfolio.
A better metric is dividend yield; the expected yearly dividend per share divided by the current price per share. Higher yields are theoretically better investments but within limits. Inordinately high dividend yields may speak to a high level of risk.
Another good measure is to compare the growth of dividend per share (DPS) with the growth of earnings per share (EPS). A stock may be showing increases in dividend per share year after year, but if earnings per share don’t grow at or near the same rate, it will ultimately be impossible for the dividend payments to continue growing apace.
Even assuming these measures look promising, income investment companies may choose stocks that pay less in dividends if the companies issuing them are fundamentally more stable. That is, dividends are not necessarily the most important factor in choosing a stock, even for an income portfolio.
Dividend income is taxed at income-tax rates rather than at lower capital-gains rates. That means that income investors are not only losing out on the potential gains to be had from dividend reinvestment but also paying more in taxes for the privilege of receiving a steady stream of income from their investments. That trade-off may be worth it, depending on the investor’s particular financial needs.
Dividends that are considered to be qualified dividends are taxed at the more favorable capital gains tax rates.