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This article explains the benefits of investing in dividend paying stocks in india, using tcs as an example. It discusses how holding good stocks for the long term can result in high dividend yields, and the importance of consistent dividend payouts and growth. It also compares dividend stocks to fixed deposits and discusses how to plan dividend stock purchases.
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People like capital appreciation more than dividend income. Why? Because dividend yields are smaller. They can be in tune of 1-2%, but capital appreciation are often in double digits.
[Check list of highest dividend paying stocks at the bottom of this post]
But does that make “dividend” less worthy? Not at all.
What comes as a package with capital appreciation is price volatility and associated risk. Predicting capital appreciation is harder. But dividend income is more rational and predictable.
In this article I will explain what makes dividend so special, irrespective of its limitations.
Favour dividend investing for these 4 reasons:
dividends are more predictable, investors feel more in control.
Buy dividend paying stocks, and hold them for long term. What is the point about ‘long term’? A stock which is yielding 0.5% at the time of purchase, can yield much higher with passage of time. How?
Let’s understand this with a real life example.
Example: TCS
Suppose a person bought shares of TCS in year Mar’09. Details are as below:
March’ Share Price (2009): Rs.132/share. No of shares bought: 10 nos. Cost paid to buy TCS: Rs.1,320. Dividend paid in 2009: Rs.14/share. Total dividend income in 2009: Rs.140. Dividend yield in 2009: 10.6%.
Suppose this person held on to his shares till year 2018. What will be his dividend yield as on Mar’18? [Note: Bonus shares 1:1 was also issued to all shareholders between Mar’09 & Mar’18]
March’2018:
Do all companies pay growing-dividends to its shareholders? No. This is why identification of good dividend paying companies is not easy. How to do it? By digging into the financial reports.
What are dividends? Dividends are nothing but a part of companies net profit. A company which make more profits, will pay higher dividends.
Dividend payment is a process by which companies share its net profit with its shareholders. Good company tend to increase its profits over time. As the profits grow, dividend payment by the company also increases.
This is hint which can be used to identify potential dividend stocks. Do the following:
Step #1 : Open the profit and loss account of the company. Step #2 : Check if the EPS has grown in last 5 years. Step #3 : Also check if dividend per share has grown in last 5 years. Step #4 : Compare if EPS growth and dividend per share growth are similar.
[Read more about how to evaluate financial health of a company]
If EPS and ‘dividend per share’ growth are similar, it is a good sign. Why? Because of the following reasons:
EPS growth means, company’s net profit is improving. Dividend per share growth mean, company believes in dividend philosophy. EPS growth similar to dividend growth means, as company profit will increase in future, its dividend payout will also improve.
Why I am comparing dividend stocks with fixed deposits? Because starting yield of dividend stocks are even lower than fixed deposits. So some might think that why to invest in dividend stocks?
Good dividend stocks offer two clear benefits to its investors:
Short term income : Though starting yield of dividend stocks can be low, but it improves with time. Moreover, good stocks can yield very stable dividend income in short term. Long Term Gain : There are two types of gains in long term. First, dividend per share will improve hence its dividend yield will also go up. See TCS example shown above. Moreover, there will also price appreciation of these stocks with time.
Though fixed deposits can give fixed interest, but it will never grow with time.
Initial yield of fixed deposit can be better than dividend yield of stocks, but there are some disadvantages as well. Income from fixed deposit is fully taxable. But dividend earned from stocks is tax free (till Rs.10 Lakhs per year).
“dividend payout %” will give a good insight. Good companies try to mimic their past dividend payout ratio.
Example:
The above chart is showing a trend of dividend payout ratio for TCS and HUL. What is the trend?
HUL : If HUL will follow this trend, most likely it will give 80% of its PAT as dividend to its shareholders in times to come.
So if we can extrapolate PAT of HUL for next 3-5 years, we will approximately know what can be a potential “dividend income” out of HUL.
TCS : If TCS will follow this trend, most likely it will give 35% of its PAT as dividend to its shareholders in the next years.
In India there are only few avenues to earn dividends: stocks and dividend paying mutual funds.
In Europe and America dividend paying exchange traded funds (ETF’s) are also available. At the moment India do not have such ETF’s.
People can buy stocks using online trading account. These days mutual funds can also be purchased using online trading platforms.
[Read more about REITs. They can also be a good source of dividend income]
If dividend paying stocks are so good, why everyone do not only buy them? Enough of only good things about dividend paying stocks. Here are some limitations of dividend focused investing. I feel, being aware of these limitations will further enhance the benefits of dividend focused investing for the investors…
High Dividend Yield is not reliable : Dividend yield is not a sufficient indicator to identify good dividend paying stocks. Stocks paying high dividend one year, and nothing the following year, is also not good. It may happen that a stock which is yielding 8% dividend today, may yield only 0.5% in next FY. Dividend is high but fundamentals are weak : Few years back Strides Pharma was yielding dividend close to 33% per annum. On Mar’14 it paid dividend of Rs.505 per share. On Mar’18 it paid dividend of only Rs.2 per share. Why it happened? Because EPS of this stock fell from Rs.593 (Mar’14) to Rs.99 (Mar’18).
People who bought this stock then, for dividend yield, must be feeling disappointed today.
Moral of the story : It is important to look at dividend yield, but in conjunction with other fundamentals like sales, profit, EPS, dividend payout %, etc.
Read more about value investing here…