Finding the best income stocks to buy today may prove to be a difficult task. The uncertain economic outlook and weak investor sentiment towards many sectors could mean that the short-term prospects for many dividend shares are somewhat challenging.
However, focusing on defensive stocks that have affordable shareholder payouts could be a good place to start. They may offer a resilient income stream. And that could grow at an above-inflation rate in the long run. This could provide you with a generous passive income, as well as a growing portfolio valuation.
The uncertain economic outlook means that defensive shares could prove to be relatively attractive income stocks. How so? Well, they may be less affected by factors such as weak GDP growth and higher unemployment than many of their index peers. This may enable them to deliver more resilient financial performances that mean less chance of a dividend cut.
Of course, defensive stocks are not without risk. For example, utility companies may have robust business models that are not closely correlated to the economic outlook. But they may face challenges (such as regulatory changes) that lead to an evolving dividend outlook. Therefore, it is important to ensure that the yield obtained from any stock is sufficiently high given its risk profile and long-term prospects.
Income stocks with affordable dividends
The future prospects for all income stocks are arguably less certain now than they have been for a number of years. Therefore, it is logical for investors to demand a margin of safety so that there is less chance of dividends being reduced.
For example, you may wish to only purchase those stocks that have dividends covered generously by net profit. This means that if sales and profitability fall in the coming months, there is a higher chance that they will be able to afford their dividend payouts. Furthermore, there may be a greater prospect of dividend growth that outperforms inflation in the coming years.
Checking the dividend cover of any income stocks is straightforward. Just divide its earnings per share by dividends per share. Any figure above one means its profit is covered by its dividends. However, in the current climate, investors may wish to demand a higher figure to compensate them for elevated risks.
Long-term growth potential
While the prospect of dividend growth may not be on the radar for many income stocks, it could make a significant difference to your overall returns. Those businesses that can grow dividends at a fast pace may not only provide a higher income for investors. Their shares could become increasingly popular in a period of low interest rates. This may produce capital gains that improve your financial prospects.
Therefore, focusing on companies with sound growth strategies that can adapt to changing economic conditions could be a sound move. It could improve your portfolio’s performance in the coming years.
The post 3 simple steps I’d take to find top income stocks to buy in October 2020 appeared first on The Motley Fool UK.
Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2020