1 0 Tag Archives: dividend yield
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What is Income Investing?

Income investing is quickly becoming one of the easiest and straight forward methods that companies use to pick stocks so that a steady stream of stable income can be created. Most of the time when investors consider options for steady income fixed income securities like bonds come to mind, however, if stocks are chosen that pay out a solid dividend then the stock market can also become an easy way to create a steady income. Of course, the trick is identifying the types of stocks that offer a steady income.

For the most part, income investors focus their efforts on established firms that have a lengthy past that have obtained success at a level in which they will not grow or expand any farther. This is due to the fact that these companies do not reinvest their earnings into the company for further expansion, but instead pay out their earnings as dividends so that shareholders always receive a return. This happens most often in industries that are no longer expanding such as utility companies and other companies that have already proved they are capable of producing a steady dividend.

However, there is much more to income investing than simply choosing to invest in companies that pay out high dividends, because the most important component to consider to determine if they are a stable source of income is the dividend yield. This can be calculated taking the annual dividend yield and dividing it by its share by price. Once you complete this calculation you will see the actual return that the stock owner receives. After you determine the average dividend yield of the company you can then determine the yield that you will receive as a stockholder which in the end is the most important figure to have at your disposal.

Outside of this factor, you also will need to look at the dividend yield alongside the past dividend policy of the company. This can help an income investor determine if the company they are looking at will continue to produce the same amount of dividends. It is very important to ascertain if the company will be able to continue to produce high shares or start to slowly decrease since once you purchase your sticks you can lose money if you are not carefully. A talented income investor that is properly educated will continue to check the dividend yield against the past dividend policy in order to continually guarantee that their investment is sound.

One sure sign that a company may be about to fall in dividends is if they have increased their dividend since a large increase may not be sustainable long term and may be a sign of over-optimism. By carefully analyzing the decision of the company and its investment patterns you can make a safe decision that takes into account if your investment is still safe and solid. Of course, before you worry about how safe your investment is, you first need to find a top dividend stock which is where careful research comes into play.

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07. Mar, 2011
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Fama–French Three Factor Model

Proponents of market efficiency divide risk into unsystematic and systematic. Unsystematic risk is not priced by everyone investing in the stock market. Here is an example to help you understand unsystematic risk. If you are considering investing in the stock market you could either buy specific stock in a specific company that you think will have a rise in price in the future. On the other hand if you don’t trust your stock ability you have the alternative of buying a basket of stocks that mimics the stock markets total combined movement. One way would to be to buy an indexed mutual fund like VFINX which is pegged to the S&P 500 which is a very large stock market index. The degree to which the stock moves relative to the general market is the unsystematic risk of the stock.

Systematic risk is the degree to which the stock changes in price relative to the general stock market as measured by an index like the S&P 500. Model calls this measure a stocks “beta.” The Fama-French Three Factor Model is a regression analysis that tries to separate out the systematic risk of a stock from the unsystematic risk by compensating for three factors. The first factor is a financial ratio called book to market. The second factor is the size of the firm as measured by its market capitalization. The third factor is the return on the market portfolio.

The book to market ratio is nothing more than what accountants estimate the company to by worth divided by the market capitalization of the company. The market capitalization of the company is the share price of the stock times the total number of shares the company has outstanding in the stock market. The return on the market portfolio is measured by some index like the S&P 500.

According to the efficient market school (which I do not agree with), size and book to market reflect systematic risk, meaning risk that requires compensation in the form of higher expected returns. If this is the case researchers should see that investors perceive small-value stocks to be riskier than large-growth stocks. The do see this which does lend some support to market efficiency. But investors consistently expect large-value stocks to outperform small-growth stocks and this is perverse. Basically, investors recognize that small upcoming companies are riskier but do not expect to be compensated for this risk as the efficient market model says that they should.

In a similar fashion, analysts tend to recommend growth stocks more favorably than they do value stocks. In the efficient market model of which the capital asset model (CAPM) is a part of, the profit from stock investing that investors expect should be as much as the risk they perceive that they are taking instead of the exact opposite which we find to be the case when actual research is performed on the matter.

This result caused the death of CAPM beta that was treasured by efficient market theorists despite the fact that the model resulted in the awarding of a Nobel Prize in economics to William Sharpe of Stanford University. Hirsh Shefrin has suggested that a behavioral beta be introduced into the model that might help explain these results that are contrary to market efficiency.

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07. Jan, 2011