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Beginner's Guide to Growth and Income Stocks

TheStreet.com Ratings Staff

01/18/08 - 01:27 PM EST
Editor's note: This is a special excerpt from TheStreet.com Ratings' Ultimate Guided Tour of Stock Investing. Other Beginner's Guides cover stock basics, market indices, diversification, financial goals and risk tolerance.

How Fast (Growth) or Slow (Income) Will You Go?

Less risk risk, less reward. This trade-off describes income stocks. These are stocks that pay high and regular dividends dividend to shareholders. Some industries known for income-producing stocks include gas, electric, telephone utilities, real estate investment trusts, banks, and insurance companies. High-quality income stocks have a long history of paying dividends, and in many cases they have a track record of regularly increasing dividends.

With growth stocks, it's the opposite trade-off: more risk, more reward. These stocks offer the greatest potential for growth, but they rarely pay dividends because profits are put right back into the company, rather than paid out directly to shareholders. Therefore, the payoff comes when you sell the stock.

Investors buy these stocks because their potential for growth is greater. Growth investors look at the rate growth-rate at which a business is growing when deciding whether to buy its stock. Normally investors buy shares of new companies, new industries and new markets that are capable of increasing earnings earnings, and other key factors that we'll study in subsequent guides.

A Portfolio to Grow By

Kathleen (see "Beginner's Guide to Financial Goals") wants to choose growth stocks to fund her children's education costs. Typically, the most common investment strategy considers age in deciding which stocks to invest in. The younger a child is, the more aggressive aggressive-growth-fund a parent can be with the investments, because the ups and downs of the market can be ridden out.

As the child gets older and closer to going to college, the investment mix becomes less risky. Kathleen would keep 80% or more in stocks when her children are young, then shift to 50% or 60% in stocks as they enter high school. Finally, when they are ready for college, she would reduce her asset allocation asset-allocation on stocks to 25%.

Guidelines for Investors of All Ages

Regardless of the benefits, Kathleen isn't comfortable taking a lot of risk to fund her children's education. She's not sure she wants to put her money into a state college plan. Right now, she wants to create her own plan so she can have control over it, and she definitely wants to be more conservative with the risk she takes.

So let's look at some moderate growth stocks with income that would do well to meet Kathleen's education goals for her children.

To research dividend-paying stocks on TheStreet.com, enter "dividend" in the TheStreet.com "Search Articles" box. You can also get dividend-paying stock stock ideas on Stockpickr.

Then, let's look at growth stocks without income, which would be more appropriate for long-term horizon goals, such as Kathleen's retirement.

To research growth stocks that might not pay dividends, enter "growth stocks" in the TheStreet.com "Search Articles" box. You can also get growth stock ideas ideas on Stockpickr.

Let's look at a few other scenarios. If Kathleen is within five years of retirement, she would want to look closely at income-producing stocks and consider investing in high-dividend-yield dividend-yield stocks, a favorite investment for this age group. In addition to providing a regular stream of income, dividends offer a cushion to investors in bear markets bear-market and a source of stability during bull markets bull-market.

With the recent change in tax treatment for dividend payments, these stocks are becoming increasingly attractive for all investors, not just retirees. The maximum tax on capital gains capital-gains-tax-cgt, which is the tax you pay on your earnings, has dropped so that the most you'll pay is 15%, but it could be as low as 5%.

But what if Kathleen changes her mind later and wants to take on more risk? What would her best choices be? If Kathleen has time to ride out the waves in the market, then she may want to consider more aggressive aggressive-growth-fund growth stocks.

Ride the Market or Look for Value Plays?

In addition, she may want to look at stocks from a few sectors sector, such as energy, financials, health care, telecommunication services or utilities, to diversify diversification and balance her risk (see "Beginner's Guide to Diversification").

Kathleen sits back with a big sigh of relief. She's got a lot of options. Risk isn't so scary once you understand it and learn how to benefit from it. She's not lost in the investing jungle after all!

To learn how to find growth and income stocks on your own, check out these tutorials on TheStreet.com: