How to diversify a portfolio with a mix of income and growth stocks
Growth stocks are those companies that reinvest profits to expand rapidly rather than pay high dividends. They tend to offer strong earnings growth, high return on equity (ROE) and are often overvalued, with priceâtoâearnings (P/E) ratios above 30.
The appeal is potential large capital gains over time. The risk is that growth projections can fail and high valuations make investor expectations fragile.
Income (dividend) stocks on the other hand provide more predictable cash returns. They pay dividends regularly. Pros include reliable income streams and sometimes lower volatility.
Cons include weaker growth, dividend cuts in downturns, and sometimes lower total return if growth lags.
The key is diversification. Itâs wise to spread exposure across growth and income stocks and across different sectors. That mix can smooth returns, reduce risk if one sector falters and provide both income and growth potential.
Hereâs an example portfolio of FTSE 100 shares split evenly between income and growth:
| Stock | Type | Sector |
|---|---|---|
| HSBC | Income | Banking |
| British American Tobacco | Income | Consumer nonâdurables |
| Phoenix Group | Income | Insurance |
| Land Securities Group | Income | Property |
| Rio Tinto | Income | Mining |
| Rolls-Royce | Growth | Aerospace |
| RELX | Growth | Commercial services |
| Next | Growth | Consumer nonâdurables |
| Sage Group (LSE: SGE) | Growth | Technology |
| 3i Group | Growth | Investments |
This example shows how different sectors contribute â banking, tobacco, mining for income; software, aerospace, investment trusts for growth.
Metrics to look for
Income stocks typically have:
- Dividend yields above 5%
- Several years of consistent dividend payments
- Healthy balance sheet, low debt, dividends covered by earnings and cash
- P/E ratio below 15
Growth stocks typically have:
- High ROE
- Strong earnings growth
- High valuation (P/E often above 30)
A growth stock example
Sage Group is a strong candidate growth stock for investors to consider among UK tech names. It has recent revenue around £2.42bn, up about 7.7â% year on year. Its ROE is approximately 36.78â% and its P/E ratio is in the low 30s â around 31.2 trailing.Â
Sageâs growth is driven by a shift to cloud and subscription-based services. The company is investing in generative AI tools in an effort to boost product performance and compete more effectively on the international stage.
But while a high valuation is typical of growth stocks, it also presents risk. If growth slows or costs rise, disappointing profit calls may disappoint investors. Another risk is competition: many firms globally offer cloud software for smallâtoâmedium business functions like accounting, payroll and HR.
Additionally, macroeconomic pressures like inflation or weak demand in certain regions could reduce growth. But if Sage can innovate rapidly enough, it should maintain market share and continue to enjoy notable growth.
Weighing up the mix
Combining growth stocks like Sage with income stocks can help an investor balance risk and reward. Income stocks can dampen volatility and offer cash flows even when growth lags. Growth stocks can drive portfolio returns when they perform well.
Investors should think about their risk tolerance, investment horizon and need for income vs growth. When picking stocks, always check financial health, growth metrics and valuation to help build a more resilient portfolio.
A wellâdiversified portfolio that includes both income and growth stocks across sectors can help smooth returns while capturing opportunity.
The post How to diversify a portfolio with a mix of income and growth stocks appeared first on The Motley Fool UK.
Should you invest £1,000 in The Sage Group plc right now?
When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets.
And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if The Sage Group plc made the list?
More reading
- This brilliant FTSE 100 dividend growth share fell 14% in August. One to consider in September?
- Finally! After its Q3 results, this FTSE tech starâs share price looks to me to have significant value in it
HSBC Holdings is an advertising partner of Motley Fool Money. Mark Hartley has positions in 3i Group Plc, British American Tobacco P.l.c., HSBC Holdings, Phoenix Group Plc, and RELX. The Motley Fool UK has recommended British American Tobacco P.l.c., HSBC Holdings, Land Securities Group Plc, RELX, Rolls-Royce Plc, and Sage Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
