Imagine this- you own an apartment in a well-located building, and you gave it on rent. Your benefit is two-fold: the capital appreciation (the value of the apartment increasing over the years) and the regular rental income. Now, buying a house is a huge investment. But what if you get this two-fold benefit in stock investment? An investment that is safe, streams in a regular income, grows in value over the years, and stabilizes the risk in your portfolio. Sounds like a dream? This dream investment is the dividend stocks. How will dividend investing help you build your aimed corpus? Let’s understand.
What is dividend investing?
Dividend stocks are key for investors seeking capital growth, like high-growth stocks and a steady income stream. In dividend investing, you focus on dividend numbers and buy stocks from companies that pay regular dividends. This strategy lets you generate passive income and steady cash flow. Moreover, reinvesting your dividends and holding onto these stocks long-term can help you build wealth and enjoy consistent returns.
How does a dividend stock work?
Imagine you buy 1000 company shares for Rs.10 each, and each share pays a Rs.0.50 dividend annually. If you invest Rs.10,000, you will receive Rs.500 in dividends over a year. This makes the dividend yield 5% [(500/100000) * 100].
The dividend yield is the income you get from dividends relative to the current stock price. The formula to calculate dividend yield is-
Dividend Yield = (Annual Dividend / Share Price) x 100
High-dividend stocks have a higher dividend yield than the benchmark they trace. Such stocks give you regular earnings and are less affected by economic cycles. Investing in high-yield dividend stocks can enhance your portfolio, especially through reinvestment. So, how do we use this to improve our portfolio?
Dividend strategies to get started:
- Reinvestment:
Dividend reinvestment can compound your wealth over time. To do this, reinvest your dividends into more shares of the same stock. If that stock looks expensive, consider buying a different value stock that also pays dividends. This harnesses the power of compounding, letting your initial investment and reinvested dividends grow over time. This strategy is effective for long-term investors aiming to maximize their portfolio growth. Maximise by how much?
Let’s say you invested Rs.10,00,000 in a dividend-paying stock. If the stock pays 5% dividends annually, you’d get Rs.50,000 annually. If you spend this Rs.50,000, your initial investment stays the same. But if you reinvest this Rs.50,000 to buy more shares, next year, you’ll earn dividends on a larger amount. Over time, this compounding effect significantly grows your wealth.
For example, if you invested Rs.10,00,000 in a dividend-paying stock with an average annual return of 8% (including dividends) and reinvested all dividends after 20 years, your investment could grow to approximately Rs.46,61,000. Without reinvesting dividends, with just price appreciation at 5%, the same investment might grow to only around Rs.26,53,200.
- Dogs of NIFTY:
The “Dogs of the Nifty50” strategy involves selecting high-dividend-yield stocks from the Nifty Index. The idea is to invest in well-established companies that are temporarily out of favor.
Check the stock’s 14-day, 30-day, and 90-day price trends for a falling pattern. This indicates the stock might be out of favor. Also, look at the dividend yield. A falling stock price usually means a higher-than-average yield. Invest in those Nifty50 stocks with falling prices and high yields (above 2.5%). Regularly rebalance your portfolio by adding more stocks at price levels where they offer higher dividends.
- Value Investing with a Dividend Focus:
This strategy combines value investing with a focus on dividend-paying stocks. Look for undervalued stocks with potential for future growth and attractive dividend yields. By targeting companies with strong fundamentals, consistent dividends, and growth potential, you can build a portfolio that delivers both income and long-term growth.
When investing in dividend stocks through any of the mentioned strategies, evaluate the companies thoroughly. But what parameters to adhere to?
Criteria for Selecting Dividend Stocks:
When picking the highest dividend-paying Indian stocks, here are some key points to consider:
- Dividend Yield: This shows the percentage return on cash dividends to shareholders. Generally, a high dividend yield is 4% or more, but it can vary by industry and market conditions. Look for stocks with a consistent record of high dividend yields.
- Dividend Growth: Check if the company consistently increases its dividend payments over time. This is usually a sign of financial strength and stability.
- Earnings and Cash Flow: Analyze the company’s revenue and cash flow to ensure sustainable dividend payouts. Aim for companies with stable earnings and cash flow growth.
- Payout Ratio: It is the percentage of earnings a company pays out as dividends. A high payout ratio might mean the company is paying out more than it can afford, which could lead to a dividend cut.
- Industry and Market Conditions: Some industries, like utilities and consumer staples, are known for high dividends. Also, consider market conditions, such as interest rates and inflation, as these can affect the performance of high dividend stocks.
- Company Financials: Review the company’s balance sheet and income statement to ensure it has a robust financial position. Check the company’s debt and credit ratings too.
Conclusion:
Stocks that pay dividends offer two benefits: income and capital appreciation. If you want more equity exposure and extra income, dividend-paying stocks are a great choice. But remember, successful long-term dividend investing requires patience, discipline, and research. So, take time to evaluate your options, seek assistance from a registered investment advisory if needed, and stay committed to your goals.
FAQs:
- What are the top high-yield dividend stocks in India?
Here are the top 3 dividend stocks based on dividend yield as of June 11, 2024:
- Indian Oil Corporation Ltd
- Vedanta Ltd
- Hindustan Petroleum Corp Ltd
- What are the benefits of dividend investing?
- The top dividend-yield stocks ensure stability and steady income.
- Building a strong portfolio with these stocks means earning through a passive income stream.
- Reinvesting dividends grows your returns steadily over time due to the power of compounding.
- Dividend payouts from strong companies offer stability and protect against inflation’s impact on purchasing power.
- How is dividend income taxed in India?
- Ordinary dividends (from direct dividend stock investment) are treated like regular income and taxed based on your income tax brackets. Since there’s no more dividend distribution tax (DDT), you are responsible for paying taxes on them.
- If you invested through a fund, companies or mutual funds deduct 10% TDS from dividends over Rs.5,000. If your actual tax due is less, you can get a refund.
