Every investor in the stock market invests their money with the aim of increasing their net worth by adopting various investing strategies.
One of the strategies is dividend investing strategy which investors might approach to increase their net worth.
Risk Averse investors are more prone to invest in high dividend-yielding stocks. Dividends are the portion of the profit that the company gives to eligible shareholders who holds the shares as on the ex-date of the dividend.
The Board of directors of the company decides on paying the dividend desirable for the company depending upon various economic and financial factors. Thus, investors adopt the approach to purchasing the stocks that issue dividends in an effort to generate a steady stream of passive income.
Most retired individuals see a high dividend yield stock as a passive source of investment for themselves. The investing strategy that investors adopt is known as a dividend investing strategy.
Reasons for Dividend Investing:
Dividends provide us with an ongoing income while we wait for capital appreciation. So, as the dividends per share continue to grow, investors will enjoy the benefit of exponential growth.
This exponential power of dividend investing growth provides a competitive return to the investors even if share price does not increase.
When the market is bear the dividend received is reinvested and more shares are accumulated during that time. This kind of investment boosts the dividend growth kind of investing for better returns in the long run.
For example: You have 2 companies namely MERCURY LTD. and NEPTUNE LTD.
Mercury ltd pays dividend and Neptune Ltd. does not pay dividends. So, if stock price of both the company rise by 5% you earn 5% and vice-versa you lose when stock price decreases by 5%.
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So, when the Mercury company pays a dividend of 4%, then you as an investor will have an overall income of 9%, if you have invested in Mercury ltd and if stock price decreases then you will only lose 1%.
But if you have invested in Neptune ltd which does not pay you dividend then with price appreciation you only gain 5% but if the price decreases by 5% then you will lose the entire notional gain. So, adopting dividend strategy is better.
But there are various other factors that need to be considered to identify which company pay high dividends and which will not.
How to Identify the Stocks with High Dividends?
When you as an investor is making a decision for dividend investing in a stocks that will pay a high dividend, then many ratios needs to be considered.These ratios are:
- DIVIDEND YIELD: This ratio indicates amount of money that is paid out as dividend each year relative to its stock price. Higher ratio indicates that higher dividend is paid out.
- PAYOUT RATIO: This ratio indicates amount of dividend paid in relation to the net income that a company generates.
- CASH DIVIDEND PAYOUT RATIO: This ratio measures proportion of cash flow that is paid to stockholders after dividend is paid to preference shareholders. Investors can use this ratio with payout ratio to get a better picture of dividend sustainability.
- TOTAL RETURN: This is the sum of capital gains plus dividends paid. This indicates how much have been earned including the increase in share prices and dividend.
- EARNING PER SHARE: This ratio indicates amount of earnings of a company each shareholder has earned. The companies whose earnings per share have grown over time indicates being the best dividend stock.
- PRICE-EARNING RATIO: This ratio indicates the relationship between the company’s stock price and earnings per share. It indicates whether fair price of the share is paid by the investor or not. Along with dividend yield it is also considered to determine if a dividend stock is fairly valued or not compared to its peers.
Let us understand this with an example:
Example: List of 10 Best Dividend Paying Companies:
Here is the list:-
| COMPANY NAME | DIVIDEND YIELD | DIVIDEND PAYOUT RATIO | EARNINGPER SHARE | PRICE TO EARNING RATIO |
| Power Finance Corp | 10.31% | 9.5 | 28.86 | 3.16 |
| REC | 10.20% | 11 | 26.88 | 3.99 |
| Oil India | 11.23% | 10.6 | 27.62 | 3.41 |
| SJVN | 9.44% | 2.2 | 3.91 | 6.01 |
| Coal India | 9.60% | 12 | 22.98 | 5.51 |
| NHPC | 7.30% | 1.5 | 3.19 | 6.47 |
| HUDCO | 8.92% | 3.1 | 8.53 | 4.12 |
| Hindustan Zinc | 6.95% | 16.5 | 237.70 | 15.70 |
| SKF India | 8.41% | 130 | 42.66 | 36.46 |
| National Aluminum | 4.32% | 1.5 | 0.30 | 116.75 |
Implication:
The above list of stock represents list of High Dividend yield stocks with corresponding dividend payout amount, Earning per share and Price Earnings Ratio.
High Dividend Yield ratio indicates that higher dividend is paid with respect to market price. But sometimes just depending on the dividend yield is like falling into a trap.
From above example we can find that National Aluminum Company has a high dividend yield of 4.32% but earning per share is less.
Thus, before making any investment decision company’s dividend history as well as balance sheet, cash debt, dividend payout, growth etc should be taken into account as a guide.
Dividend Investment Strategy:
Dividend investing strategy is an important part of portfolio management. Under this strategy investors are allowed to reinvest their cash dividend in additional shares or in the fraction of shares of the underlying stock on the dividend payment date without any fees or commissions.
This strategy is good for investors when they are investing for long term purpose because in the long run returns that shareholders receive is compounding. So, when dividends are increasing investors are receiving higher income on each share they own which can be reinvested to purchase more shares.
How are Dividends Taxed?
For an individual shareholder, dividends are taxed as per the applicable slab rates. According to section 115BBDA of the Act the government has abolished additional tax of 10% on dividend income in excess of Rs.10 lakh per year for resident non-corporate taxpayers.
For corporate shareholders, dividends are taxed as per the effective tax rates, ranging from 25.17% to 34.94%.
As per the provisions of the Act Indian companies are liable to withhold taxes at the rate of 20% on payment of dividend to a non-resident shareholder. Various other tax treaties a lower tax rate, typically ranging from 5% to 15%.
Pros and Cons Of Dividend Investing:
Every strategy has their advantages and disadvantages. Some of the advantages of dividend investing are listed below.
- Dividends are a stable source of income for individualsas it can be utilised to fulfil any personal needs, or for reinvesting in the stock market. Such returns ensure high yields for investors.
- Since large cap companies issue dividend they possess a strong market presence and mitigates the risk factors. So, unfavorable fluctuations in the market price of a stock do not affect the company’s dividend paying capacity.
Some of the disadvantages of dividend investing are listed below.
- Capital gains cannot be made from dividend paying stocks as they are issued by large companies that does not demonstrate fluctuations with high variations.
- Since paying dividend is not mandatory company will only pay dividend if it will generate substantial profit. So, as a result growth opportunity is limited.
Key Takeaways:
- Dividends are the cash flows received by an investor from the profits generated by the company
- The dividend provides an ongoing return allowing the investor to benefit from the exponential growth of the company.
- Investors adopt the approach to purchasing the stocks that issue dividends in an effort to generate a steady stream of passive income.
- When dividends of any company are increasing it means that the operational efficiency of the company is also robust.
- For an individual shareholder, dividends are taxed as per the applicable slab rates and for a corporate shareholder, dividends are taxed as per the effective tax rates, ranging from 25.17% to 34.94%
Happy Learning!
