SIGNIFICANCE
A company doing well and generating profits will usually be in a position to declare dividends regularly. Hence, a key parameter one should look at whilst investing in a stock is whether the company has a good dividend record. Typically, dividend yield stocks are large-caps and generally not capital-intensive. This is suggestive of the fact that the downside risk on these stocks is lower.
When equity markets run amuck, sometimes deserving companies do not receive their rightful due in terms of the market price. These can be testing times for the investor, for he sees consistent top line / bottom line growth but the stock price fails to move. In such circumstances, dividends come to the rescue of investors. Provided, the management is generous enough to pass on the upside to shareholders. As a policy, one's portfolio must include at least a few stocks that yield dividends on a consistent basis. Typically, these are the stocks that one should hold with a longterm perspective.
Purchase time? There were several lessons from the 2008 debacle. People stopped looking only at returns and identified with the concept of risk. This made several investors re-visit their investments and buy stocks that are fundamentally sound. After the meltdown, dividend -yielding stocks became very popular. And equity, was no longer looked at just as an instruments that offered capital appreciation. It was also perceived to be an instrument that could provide a stable income in the form of dividends. This was also the time of high DPS (dividend per share). With prices of stock having fallen sharply one could earn decent returns on relatively low capital outflows.
It is important to time your entry into astock and ensure you do not buy at a time when it is overvalued. The beginning of the new financial year ushers in the annual dividend season. This is, thus, the best time to take long positions in those coveted dividend yield stocks. Beginning from the middle of April, companies that follow the April-March financial year (followed by a majority) will start announcing and doling out their annual goodies for shareholders. And, remember, dividends are also tax-free in the hands of the investor! A dividend yield of 6.5 per cent is equivalent to 9.5 per cent returns earned in case of taxable income.
Dividends, in fact, tend to be more stable than corporate profitability. Companies tend to maintain their dividend payout patterns even during periods of lull, to ensure investors continue to stay invested with them. The consistency of dividends is also driven by the fact that promoters (who generally hold large chunks of shares) depend on them as a source of income. For example, as a result of Hero Honda's declaration of a dividend of `70 per share, the Munjals (promoters) earned themselves about `730 crore.
EVALUATION
Dividend-paying stocks are evaluated mainly based on two parameters. Dividend per share is the total of dividends paid out over an entire year (including interim dividends, but not including special dividends), divided by the number of ordinary shares issued. Dividend yield is a financial ratio that shows how much a company pays out in dividends each year, relative to its share price. In the absence of any capital gains, the dividend yield is also the return on investment (ROE) for a stock.
In both cases, the higher the ratio, the better it is. It shows that the company has been worth the money invested, paying decent dividends. However, you may also like to dig a little deeper and check if they have made dividend payouts when the markets were downward trending.
However, a high dividend yield is not always good. There is a school of thought that believes it means a poor quality of business. If the management has a policy which sees the bulk of profits distributed to shareholders, it means they don't have any other profitable ways in which to reinvest the same in the business. Being able to see through these intricacies and adding the right stock to your portfolio takes some thinking and analysis.
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