What are income versus growth shares?

Shares play an important role in a balanced investment portfolio and they can generate a return on investment in two ways – through income in the form of dividends, or capital growth.

In an ideal world, you would invest in companies that pay consistently high dividends and record consistently high capital growth, and while it’s possible for companies to sometimes combine the two, most are seen as either income or growth options.

Income stocks

These are companies that reliably pay a high percentage of their earnings as dividends to shareholders. They are often in mature industries with relatively consistent sources of revenue but moderate or slow growth.

Examples include utility companies, because customers are likely to use a similar amount of gas or electricity year on year.

Companies of this nature are not likely to offer the opportunity for high growth and so they aim to keep shareholders satisfied with reliable, regular and generous dividend payments.

Australian banks and telecoms companies are also recognised for paying dividends. When lots of investors are attracted to income stocks, when interest rates are low for example, their share prices can rise faster, meaning they deliver capital growth too.

However, this trend has the potential to be reversed if interest rates rise.

It is now also possible to buy exchange traded funds that provide exposure to a range of high dividend paying companies.

• An income strategy can be suitable if you’re looking to supplement or replace an income, for example, when you’re close to retirement
• The value of income stocks can rise and fall in value so as an income yielding investment, they shouldn’t be compared directly with a term deposit

Growth stocks

These are companies focused on expansion, offering the potential for capital growth as share prices follow earnings and profit higher. However, their share prices can be more volatile because earnings are less predictable.

They are more inclined to reinvest earnings into product research and development, entering new markets or acquiring other businesses in order to grow.

This leaves less money, if any, available for dividends.

A company investing heavily to expand in pursuit of exponential market share or sales growth might be labelled an ‘emerging’ or ‘aggressive’ growth company.

Several years later it might begin to use some of its earnings to pay a modest dividend. At that stage, it might be considered an ‘established’ growth company.

• A growth strategy might suit you if you’ve got a long-term investment horizon

Original article published at CommSec.com.au