Income Ratings
Income Ratings, which use a scale of 0 – 5, indicate the current attractiveness of a stock for income generation. Stocks with ratings closer to 5 are likely to be better opportunities to maximise safe and growing passive income compared to those with ratings closer to 0.
All ratings should only be used to complement your own due diligence when making investment decisions.
Income Ratings Introduction
Income Ratings are determined by a proprietary algorithm that incorporates a stock’s quality and dividend yield. This approach aims to identify stocks that can maximise an investor’s income generation, without compromising on the safety and growth of that income.
Dividend payouts are extremely attractive, since they represent a tangible return that an investor receives on an investment. As such, the dividends are often used to measure the relative appeal of an individual stock. Companies that grow their revenues and free cash flow (FCF) over time can reward their shareholders with higher dividend payments, thereby creating a steady stream of passive income for investors.
High-quality stocks with high dividend yields tend to receive the best Income Ratings (closer to 5), while low-quality stocks with low dividend yields tend to receive the worst Income Ratings (closer to 0).
For more on the components of the Income Ratings, see Income Ratings Components. Over time, RatedA may update the Income Rating algorithm.
Income Ratings Explanation
3.33 – 5.00: If an investor is looking for income-generating stocks to add to his or her portfolio, these stocks may be the best candidates for consideration.
1.66 – 3.33: An investor holding a stock at these levels should consider whether there are better opportunities for income generation.
0.00 – 1.66: An investor holding a stock at these levels should consider whether it’s suitable to replace it with a better income-generating opportunity. An investor looking for income-generating stocks would not usually consider these stocks for purchase.
Income Ratings Components
Dividend Yield: One method businesses use to return value to shareholders is through dividend payments. This allows a company to distribute a portion of its free cash flow (FCF) as a cash payment.
The ratio of the cash dividend to the stock’s price is known as the dividend yield. For example, a stock with a price of $100 paying out a yearly dividend of $10 has a dividend yield of 10%. As a company’s stock price rises, the dividend yield decreases. Conversely, as a company’s stock price falls, the dividend yield rises.
Companies can decide to pay dividends monthly, quarterly, yearly, or on special occasions only. As a company grows its free cash flow, it will often also grow its dividend payments.
It is important to note that dividend growth is not guaranteed, however. Companies may need to reduce or completely eliminate their dividend if their cash flow cannot sustain it.
Quality: The integration of the quality component into Income Ratings is designed to avoid the pitfalls of “yield traps“. These are stocks with dividend yields that may seem attractive but are actually unsustainable and likely to be reduced or eliminated.
High-quality companies share some common characteristics. They possess a moat that serves to protect profits and market share from competitors, leading to more durable cash flows.
These companies are also highly profitable; they typically generate better returns on capital and have an easier time growing cash flows.
Lastly, high-quality companies are relatively safe from uncertainty; by having less variability in future expected outcomes, their cash flows are more predictable.
As a result, dividend payments from high-quality companies tend to be more sustainable and experience faster growth.
Why Use Income Ratings
Dividends have played a significant role in the returns investors have received during the last several decades. Legendary investors Benjamin Graham and David Dodd famously called dividend payments “the prime purpose of a business corporation… A successful company is one that can pay dividends regularly and presumably increase the rate as time goes on.”
Investors may choose to adopt an investing strategy centred around dividend income for a variety of purposes. For instance, a large portfolio of dividend-paying stocks can provide the necessary income to live comfortably in retirement without having to rely on the sale of assets.
Re-investing dividend payments can also accelerate the compounding process, especially when stock prices fall, like they often do in periods of economic contraction.
Special Considerations
Here are some special considerations when using our Income Ratings.
Consider the following:
- The quality of the ratings depends on the accuracy of financial data provided by third parties, including the companies in our coverage.
- This approach is optimised for an income generation strategy. Income Ratings might not be suitable for investors aiming to maximise total returns from stock investments.
- The dividend yield component of Income Ratings is calculated by extrapolating a company’s last dividend payment over the next 12 months. One-time special dividends are excluded to avoid any distortions.
- The quality component of Income Ratings uses Quality Ratings as the primary metric for business quality. Quality Ratings are typically updated annually, shortly after companies publish their annual reports. Quality Ratings are focused on long-term outcomes. While the overall quality of a company does not change materially from quarter to quarter, our ratings may not reflect the possible impact of recent news and business developments. Investors should always do their own research before making a trading decision.
- Income Ratings and all related publications are not personal recommendations for any particular investor or client. All opinions provided are based on sources believed to be accurate and are written in good faith, but no warranty, representation, or guarantee, whether expressed or implied, is made as to the accuracy of the information provided by our service.
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