Whenever a regular retail investor, like you and me, buys a stocks, then their main aim is to make money through their investment. There are basically two ways by which anyone can earn money by investing in stocks. They are 1) Capital Appreciation & 2) Dividends.
The first one, capital appreciation, is quite simple and hugely famous among investors. Everyone knows this secret to earn in the stock market. Buy low and sell high. The difference is your buying and selling price is capital appreciation or profit.
For example, suppose you bought 200 stocks of a company at Rs 100 and two years hence, the price of the stock has increased to Rs 240. Here, capital appreciation is Rs 240- Rs 100 = Rs 140 per share or 140%. The overall profit that you made on your investments will be Rs 140*200 i.e. or Rs 28,000.
Almost everyone who enters the market knows this method of earning by stocks. It can also be concluded that most people enter the market hoping that their investment will be doubled or quadrupled and will make them a millionaire one day through capital appreciation.
What are Dividends?
Whenever a company is for profit, it can use this profit amount in different ways. First, it can use the profit amount in its expansion like acquiring a new property, starting a new venture/project, etc. This strategy is generally used by fast-growing companies. Second, it can distribute the majority of the profit among its owners and shareholders. Third and final, it can distribute some portion of the profit to the shareholders and use the remaining in carrying out its expansion work.
Basically, this amount distributed by the company (from its profit) among the shareholders is called DIVIDEND.
What is a dividend? “A dividend is a distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.”
Typically, most big and well-established companies give decent dividends to their shareholders. They may offer dividends two times a year, namely– Interim dividend and final dividend. However, this is not a hard and fast rule. A few companies, like MRF, give dividends three times a year. If you’re holding a stock of these companies and the company announces a dividend, then you’re eligible to receive the dividends as you’re a legal shareholder.
Why are dividends good?
Suppose you are a long-term investor. You have invested in the stocks of a company for the next 15-20 years. Now, if the company does not give any dividends, there is no way for you to make money until you sell the stocks. On the other hand, even though your investments might be growing, however, you won’t receive any cash in the hand unless you sell.
Nonetheless, if the company gives a regular dividend, say 3-4% a year, then you can are receiving some returns from your investments. Here, your capital is growing as you’ve not sold your stocks. Along with it, you’re also receiving some dividends being a loyal shareholder of the company.
In addition, a regular dividend is also a sign of a healthy company. An entity that has given a consistent (moreover growing) dividend to its shareholders for the last 5-10 consecutive years, can be considered a financially strong company. On the contrary, the companies that give irregular dividends (or skips dividends in a bad economy or market crashes) can not be considered as a financially sound company. Therefore, big dividend yields can be an incredibly attractive feature of stock for the long term value investors.
Must know financial terms regarding Dividends
Here are a few terms that every dividend investor should know. These key terms are frequently used while discussing dividend stocks.
1. Dividend yield: A stock’s dividend yield is calculated as the company’s annual cash dividend per share divided by the current share price. It is expressed in annual percentage.
Dividend Yield = (Dividend per Share) / (Price per Share)*100
2. Dividend %: This is the ratio of the dividend given by the company to the face value of the share.
3. Payout ratio: It is the ratio of earnings paid out as dividends to shareholders divided by the total earnings by the company in that year. Dividend payout ratio typically expressed as a percentage and is calculated as follows:
Payout Ratio = Dividends per Share (DPS) / Earnings per Share (EPS)
As a thumb rule, avoid investing in companies with a very high dividend payout ratio. This is because a high payout ratio means the company is not retaining enough money for its expansion or growth. In other words, be cautionary if the payout ratio is greater than 70%.
An intelligent dividend investor looks for a company that can provide consistent dividends for many long years without any dividend cuts. He/She is not interested in those companies giving high dividends just for one year and not able to sustain giving similar dividends in the future. That’s why it is really important that the fundamentals of the company should be strong, along with the dividend history. A bad market, slowdown, or recession should not stop good dividend companies from giving dividends to their shareholders.
That’s all for this article. I hope this post on ‘Ten Best Dividend Stocks in India’ is useful to the readers. Further, I will highly recommend not investing in stocks based on the list mentioned above. Do your independent research and invest only when you’ve studied the company enough and confident about its fundamentals.