Understanding the stock market
Saturday 06 December 1997
Shareholders are part owners of a company. Should all go well, they will receive a share of their company's profits, known as dividends, usually twice a year. However, companies do not pay out all of their profits to their shareholders.
A proportion is retained to plough back into the business. Technically, undistributed profits are "transferred to reserves" in years when the profits are not as good, so the company can pay dividends from reserves.
When a company prospers, shareholders' rewards are two-fold. In addition to receiving a regular income, they will also hopefully see their shares increase in value.
This is because the profits retained in the business will be put to good use. In turn, this should increase earnings and therefore the value of the business. The result to the shareholder will hopefully be an increasing share price, with dividends rising each year.
This sounds ideal - in theory. However, if you look at The Independent's shares page, you will notice that returns are generally low.
High returns are usually associated with riskier shares. The yield column on the page expresses the last gross annual dividend as a percentage of the current share price. It is the exception rather than the rule to find a gross yield above 5 per cent - most produce less.
Investors who are seeking income from their shares will no doubt be disappointed, as they can generally secure higher returns from simple savings accounts.
Naturally everyone needs a contingency level of savings which provide instant access.
It is also true that higher returns can be obtained from notice or fixed- term accounts. However, maximising short-term returns with savings accounts can be to the detriment of future income.
It is essential for every investor to have a comfort level of savings.
It is equally important for those who will be relying on investment income to consider taking steps to ensure that their income increases over time, even if this means forgoing income in the early years.
This may not be a route that everyone is able, or indeed would wish, to take. It requires planning and professional guidance.
Ideally, in addition to funds in instant access and term accounts, consideration should be given to securing a guaranteed level of income.
This may be achieved by investing in gilts, which are Government securities. These were the subject of this column last month when it was explained that when the current price for a dated gilt is more than pounds 100, it means that the investor will make a loss when the security is redeemed.
Although such gilts pay a high dividend, it must be understood that a proportion of the income paid every year is effectively capital.
When investing for income, the advice is usually that 40 to 50 per cent of a portfolio should be in securities producing a fixed level of income.
If contemplating investing in gilts, professional advice should be sought from a stockbroker or independent financial adviser (IFA).
However, ordinary gilts do not give protection against inflation. An alternative course would be to invest in a fixed interest unit trust.
John Hutton-Attenborough, of IFA Berry Birch & Noble, says it may be worth contemplating the Commercial Union Income Unit Trust which currently yields an income of 7.6 per cent.
This need not be to the detriment of the invested capital. Over the past 12 months, a pounds 1,000 investment would now be worth pounds 1,177 if dividends had been invested. Over five years pounds 1,000 would have risen to pounds 1,780, which is an annual growth rate of 12.2 per cent.
In effect, the fund has grown by a considerable amount more than the amount paid in income over the years.
So as to spread the risk, any shares portfolio should contain at least six holdings spread across different sectors.
In order to absorb the cost of buying and selling the shares, the minimum economic holding per share is around pounds 2,000.
This may not be affordable by more modest investors. However, there is a solution - unit trusts which invest in a mixture of fixed income stocks and shares.
Mr Hutton-Attenborough says the Jupiter Income Unit Trust is well worth considering. With income reinvested, the return over the past year has been 21.6 per cent and an annual equivalent of 27.5 per cent over the past five years.
However, the dividend yield is only 3.7 per cent. This means that pounds 1,000 invested a year ago would have produced an income of just pounds 37.
At the same time, pounds 1,000 invested five years ago would now produce an annual income of pounds 124.51, which is equivalent of 12.45 per cent gross.
This emphasises the fact that that when investing in the stock market for income, one should take a longer-term view and be willing to sacrifice a low initial income for higher dividends later.
Readers contemplating investing in the stock market for income are recommended to seek professional advice.
Independent Partners; request a free guide on NISAs from Hargreaves Lansdown
Presents unwrapped, turkey gobbled... it's time to relax
You'll need £220,000 for a minimum wage in your retirement
Money Insider: Would £150 make you switch banks?
Why the City Watchdog is concerned with the credit card industry
Bargain Hunter: Find the deals that have real value beneath the Black Friday hype
Gold-plated pensions – the key to retirement freedom?
- 2 This letter from a reader explains why women can’t play football
- 4 Scientists predict green energy revolution after incredible new graphene discoveries
Ukip says babies born to immigrants in the UK should be classed as migrants – which would include Nigel Farage’s own children
Obama: The only people with the right to object to immigration are Native Americans
The young are the new poor: Sharp increase in number of under-25s living in poverty, while over-65s are better off than ever
Tamir Rice: 12-year-old boy playing with fake gun dies after being shot by Ohio police
Ukip mocked after mistaking Westminster Cathedral – for a mosque
Sarah Vine criticises lesbian mother Jack Monroe: 'If she was unsure about her sexuality, she should have taken greater precautions'
iJobs Money & Business
£Attractive Package: Citifocus Ltd: Prestigious asset management house seeks a...
£Negotiable: Citifocus Ltd: This is a varied role focusing on the firm's mutua...
£90000 - £140000 per annum + benefits: h2 Recruit Ltd: Are you a high achievin...
£25000 - £37000 per annum + benefits: h2 Recruit Ltd: Are you seeking to furth...
Day In a Page
A deceptively spacious, beautifully presented Georgian home with 3000sq ft of living space and five reception rooms
A five-bedroom Victorian home with four receptions, superb gardens and paddock in Pembury
An eight-bedroom house on the south side of the The Green with cinema, wine cellars and summer house
This 17th century beauty is full of rustic cosiness, while the detached home office means you can also run a business
This five-bedroom red-brick beauty overlooks the village green and sits in just under two acres of land
Four exclusive apartments in a Grade II-listed former medical school with 2,275 sq ft of living space and 18ft ceilings
A five-bedroom terraced house on the popular Peterborough Estate, ideally located for both Eel Brook Common and South Park
A state-of-the-art farm-building conversion on the former Cliveden Estate, with 11,420sq ft of internal space, cinema and wine cellar
A three-bedroom, 15th-century cottage with original features in the picturesque village of Sissinghurst
A six-bedroom terraced house with large south-facing roof terrace, cinema room and wine cellar
A new seven-bedroom home built in Queen Anne-style with swimming pool and parkland views in Mortimer
A listed, four-bedroom farmhouse in the rural hamlet of Rushall with detached barn, four acres of gardens and paddocks
A first-floor flat with two bedrooms, a spacious reception room and communal grounds in a leafy part of London
A three-bedroom flat with a spacious rootop terrace and balcony, accessed from a private gated courtyard
A Grade II-listed pile with six bedrooms, stables and 39 acres of grounds in Standlake
A two-bedroom flat with boutique hotel-style interiors, close to the foodie haunt of West End Lane
A two-bedroom flat in a beautiful old vicarage, with many original features, close to the city centre
A three-bedroom 16th-century home with an aga kitchen, private gardens and heated outdoor pool, in Hadleigh
A three-bedrom home in sought-after Queen's Gate Mews, with Italian marble-finished bathrooms
Surrounded by glorious countryside in the village of Udimore, sits this impressive four-kiln oast and barn conversion
A five-bedroom house in the picturesque village of Kettlewell, north Yorkshire
An 18th-century former coaching inn with original staircase, open fireplaces and beams throughout
A Grade II-listed Georgian town house with three bedrooms and a south-facing courtyard, near Arundel Castle
Feel on top of the world at this über chic penthouse on the 37th floor of one of Europe’s tallest blocks.
A Grade II-listed Victorian villa with six bedrooms and two further cottages, all with spectacular sea views
A grade II-listed, Georgian cottage with mature 50ft garden, perfect for summer entertaining
A magnificent Georgian pile with turrets, seven bedrooms, a heated pool and four acres of gardens
Fairoak Farm has five bedroom suites, gym, outdoor swimming pool and golf course
Chic two-bedroom river-fronted flat with a private lift that delivers you directly to your home
A spectacular seven-bedroom Tudor pile, once owned by Henry VIII, with 18 acres of land
A seven-bedroom Georgian property previously used as a picturesque wedding venue
A split-level flat in a church conversion with two en suite bedrooms and 1,200sq ft of living space
A three-bedroom bungalow situated behind an impressive stone wall, £645,000
Windsor Castle overlooks this three-bedroom Victorian cottage located on one of Windsor's smartest roads
Chapel House is a former vicarage with nine bedrooms in the beautiful Upper Wye Valley
A five-bedroom B&B and separate owner's accomodation with potential for conversion
Enjoy summer by the Thames in this two double-bedroom converted warehouse in Rotherhithe village
A one-bedroom, luxury apartment with private gym and concierge service in Moorgate
A four-bedroom house in Hermitage Gardens with three reception rooms and landscaped gardens