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3 Income Filters to Keep Your Cash Flowing

Posted November 11, 2021

Zach Scheidt

By Zach Scheidt

3 Income Filters to Keep Your Cash Flowing

I have a weekend process that I absolutely love.

(No, it's not going to Chick-fil-A for milkshakes with the kids, although I do enjoy that as well.)

When the stock market is closed and there are no news alerts or price action to distract me, I take some time to look through dozens of stocks. 

It's part of my process to help you invest in the best income opportunities the market has to offer.

Typically, I start by flipping through chart patterns to see which way different stocks are moving. 

Then I look through the financial data for specific plays that have been in news. 

And after I've looked through every name on my watchlist, I mark down the top picks that are worth sharing with you in the week ahead.

I do all of this because I love finding great income plays. And I love helping you get more cash!

Today, I wanted to share the three most important filters I use to weed out the bad income opportunities. 

That way you can look through your list of income plays and pick out the ones that make the most sense for you.

Filter #1: How Reliable Is My Income?

As an income investor, there's nothing that ticks me off more than when a company cuts its dividend payment.

We saw it happen for a few income plays during the coronavirus crisis. And to be fair, that may have been the smart thing to do with so much uncertainty.

But when a company just decides not to pay a dividend or to reduce the amount of income they pay you, it makes me mad.

Fortunately, my first filter helps to keep this from happening.

When you're looking for great market income plays, the first thing you need to do is look at how much profit a company is generating and compare it to how much they're paying in dividends.

Generally speaking, I like to see dividends account for somewhere around 40% to 60% of a company's profits.

If the number is less than 40%, it may mean that management isn't really paying you as much as you should expect. 

In situations like this, I at least want to see that the company has a history of raising its dividend payment. If that's the case, we may be receiving a larger share of the company's profits in future quarters.

If the number is greater than 60%,I start to worry about the risk of a dividend cut.

All it takes is one or two weak quarters and the company's management team might decide to save money by paying less to shareholders. 

That's not always what happens, but it's one of the risks that I keep a close eye on.

Companies that pay a dividend in the sweet spot of 40% to 60% of regular profits give you the most reliable income.

Also, when you're looking at the reliability of your income, don't forget to check how much debt the company has. Too much debt is also a red flag.

Filter #2: Will My Income Grow?

The second factor I focus on is the likelihood that your income will increase over time.

To get a feel for how well your income could grow, you should start by looking at the underlying business.

Ask questions like:

  • Is the company expanding into new markets?
  • Are new products being launched?
  • Are customers paying more over time?
  • Does the company have a history of increasing its dividend?
  • Has management made income to shareholders a priority?

Of course, there's a lot to look at here. And that's why you've got me! 

My goal is to do a lot of the heavy lifting so you don't have to be the one researching all of this information.

Still, as you look at your own stocks that you're interested in and build a watchlist of income opportunities, it helps to understand what to look for in the best income plays.

Filter #3: How Much Income Do I Get Compared to My Investment?

The final filter I use tells me how much income I get for every dollar I invest.

On Wall Street, this is known as current yield. That's just a fancy way of measuring the bang for your buck.

To calculate the current yield for your income play, start with the total amount of income you expect to receive in the next year. (For a company that pays quarterly dividends, just multiply that dividend by four.)

Take the annual income and divide it by your investment. This gives you a percentage number similar to an interest rate you're being paid for your investment.

Let's say you're considering a stock that trades for $50. The company pays a quarterly dividend of $0.50 per share. So you're getting $2.00 per share every year.

Simply take the $2.00 and divide it by $50. That gives you a current yield (or interest rate) of 4.0%. Not bad, considering most savings accounts still pay less than 1% per year.

The thing I like about the best dividend stocks is that they give you a healthy yield and give you a chance to grow your wealth.

If you're invested in the best income plays, the price of your shares should steadily move higher while you're also receiving quarterly payments that keep growing. That's the hallmark of a quality income play.

Hopefully, now you know more of what to look for when you scout out your next income play. 

And of course, my team and I are constantly researching the best plays so we can bring them to you here at Rich Retirement Letter.

Here's to living a Rich Retirement,

Zach Scheidt

Zach Scheidt
Editor, Rich Retirement Letter

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