Rule #1: Search for sustainable long-term dividend growth. Investing in businesses whose growth potential is not reflected in the valuation of their shares not only reduces the risk of losing money, it increases the upside opportunity.
Rule #2: Inflation matters. Always bear in mind the detrimental effect of inflation. Corporate and government bonds offer higher yields than cash, but returns can be eroded by inflation. Investment in property or equities provides a vehicle to help achieve an income that rises to keep pace with inflation.
Rule #3: Patience is a virtue. Investing for income is all about the compounding of returns for the long term. As a general rule, those businesses best placed to offer this demonstrate consistent returns on invested capital and visible earnings streams.
Rule #4: Reliability is the key. Select sectors of the equity market that do not depend on strong economic growth to deliver attractive returns.
Rule #5: Find high and growing free cash flow. Look for companies with money left over after all capital expenditures, as this is the stream out of which rising dividends are paid. The larger the free cash flow relative to the dividend payout, the better.
Rule #6: Look for dividend growth. In the short term, share prices are buffeted by all sorts of influences, but over longer time periods, fundamentals have the opportunity to shine through. Dividend growth is the key determinant of long-term share-price movements-the rest is sentiment.
