Typical Income-Producing Stocks for Investors - dummies

Typical Income-Producing Stocks for Investors

By Paul Mladjenovic

Although virtually every industry has stocks that pay dividends to investors, some industries have more dividend-paying stocks than others. Utilities and royalty trusts are among the best generators of dividends.

Utility stocks for income generation

Utilities generate a large cash flow. Cash flow includes money from income (sales of products and/or services) and other items (such as the selling of assets, for example). This cash flow is needed to cover expenses, loan payments, and dividends. Utilities are considered the most common type of income stocks, and many investors have at least one utility company in their portfolio.

Investing in your own local utility isn’t a bad idea — at least it makes paying the utility bill less painful.

Before you invest in a public utility, consider the following:

  • The utility company’s financial condition: Is the company making money, and are its sales and earnings growing from year to year? Make sure the utility’s bonds are rated A or higher.

  • The company’s dividend payout ratio: Because utilities tend to have a good cash flow, don’t be too concerned if the ratio reaches 70 percent. From a safety point of view, however, the lower the rate, the better.

  • The company’s geographic location: If the utility covers an area that’s doing well and offers an increasing population base and business expansion that bodes well for your stock. A good resource for researching population and business data is the U.S. Census Bureau.

Royalty trusts as income-generating stocks

In recent years, the oil and gas sector has generated much interest as people and businesses experience much higher energy prices. Due to a variety of bullish factors, such as increased international demand from China and other emerging industrialized nations, oil and gas prices have zoomed to record highs. Some income investors have capitalized on this price increase by investing in energy stocks called royalty trusts.

Royalty trusts are companies that hold assets such as oil-rich and/or natural gas–rich land and generate high fees from companies that seek access to these properties for exploration. The fees paid to the royalty trusts are then disbursed as high dividends to their shareholders.

During early 2012, royalty trusts sported yields in the 7 to 12 percent range, which is very enticing given how low the yields have been in this decade for other investments like bank accounts and bonds. See Appendix A for resources on royalty trusts and other income investments.

Although energy has been a hot field in recent years and royalty trusts have done well, keep in mind that their payout ratios are very high (often in the 90 to 100 percent range), so dividends will suffer should their cash flow shrink.