June is when it rains. For stock investors, it is the month when it rains dividends. Every year, companies announce and distribute dividends from their profits around this time. If you scout for some stocks with high dividend yields, you should receive a nice pay-off or a decent income from your investments in just a few months.
You can also expect higher dividends. In FY 2013, profits of companies increased nine per cent in the sample size of firms that have declared dividends while their dividend payouts increased 17.6 per cent. Which means investors can look forward to larger payouts this year. The dividends are directly credited to your bank account these days so you could look forward to a good income in your hands in the coming months.
A dividend payout policy varies between companies. Some companies have a higher payout whereas others have a lower payout as it depends on their capital requirements. It's sometimes a bond of contention between shareholders and management. Some shareholders may want a larger dividend; management might want to retain the excess cash for growth.
Investing in dividend-paying stocks is often a good long term strategy followed by some savvy investors, as these companies usually have healthy cash-flows and better profitability. The general theory goes that those companies that pay out a large part of their profits to the shareholders as dividends usually do not need much cash for growth. Hence, investors tend to benefit more as more earned profits are distributed rather than accumulated. These companies also do not raise money from the capital markets very often and, therefore, returns on shareholder capital remains robust.
Often though, the stock market assigns a higher valuation to dividend pay masters. On the flip side, the market sometimes ignores companies that pay a nice dividend. The market price of the stock falls so much that the dividend per share you receive in your hands becomes quite attractive on the investment you made. In other words, you receive a healthy dividend yield.
Dividend yield comes into play when stock markets are down, or when stocks are beaten or when you want a decent income from your stock investments. The amount of dividend declared by a company per share is its dividend yield. So, if a company declares Rs 5 a share as dividend, while its market price is Rs 100, the dividend yield here is five per cent (5/100*100).
Some sectors like the public sector undertakings or others like utilities tend to have a high dividend yield. Logistics and commodity stocks sometimes also have a higher dividend yield.
Dividend yield rises when the stock prices of high dividend paying company falls. So when markets go through bouts of high selling, investors should go scouting for dividend yield companies as their yields improve.
Says V K Sharma, head of business (private broking and wealth management) at HDFC Securities: "In fact, there have been times when dividend yields offered by public sector banks (which are usually high-dividend paying companies) have been higher than the interest on bank fixed deposits."
Another factor to watch closely is a combination of the payout ratio and consistent profits. A stronger company usually has an excellent track record on dividends.
Says Pankaj Pandey, head research, ICICIdirect.com: "Ideally, one should look for companies that have good dividend payout ratio and profit."
Sometimes though, if the dividends are huge, the stock price might take a dip after the dividend is paid out. However, according to Sharma, even if this happens, investors should hold on to these stocks, since these are essentially not trading stocks. Often, these stocks tend to bounce back next year once again during the dividend paying season.
"PSU banks are a good option if you are looking for dividend yield stocks, but you may have to hold them for a longer time," says Sharma. "If a company is paying higher dividend, it is confidence boosting, because it means the company is making good profits. The company is paying dividends out of its profits and is not dipping into its reserves," he adds.
Mutual funds that track companies offering high dividend yield have done well in the market. Such funds became popular two to three years ago, when companies started paying higher dividend. But these are stocks that not only pay high dividend but also perform well. Usually, multinational companies pay a slightly higher dividend. For instance, UTI Dividend Yield Fund has returned 14.93 per cent the past year.
One big advantage: dividends are tax-free in the hands of investors, unlike the interest earned on bank fixed deposits. If a company yields 5.25 per cent, a fixed deposit would have to earn at least 7.5 per cent in interest for those investors in the 30 per cent tax bracket. That's because, 2.25 per cent of the interest will have to be paid as taxes. Capital gains on stock investments are taxed at a lower rate of 10 per cent, making dividend-yield investing highly tax-efficient.
Finally, dividend-yield is a conservative strategy, which does take time to deliver returns. But the upside is, dividend-yield companies are undervalued and the yield provides a cushion against a downside. Such stocks might fetch you handsome capital gains if these stocks are re-rated. But even if they don't bag you high capital gains, a steadily rising dividend yield every year will increase boost your overall returns but without too much risk. So, keep your eyes trained on the medium term, and reap a good harvest from these stocks.
WHEN DIVIDEND YIELDS PAY
- Companies can increase their dividend payouts when profits rise
- Apart from capital appreciation, dividend yields boost your returns
- Investors do not have to pay taxes on dividends received
- Investors can chase stock prices higher and drive down yields
- When such stocks dip, investors lose their capital, thus negating yields