fbpx
PROS & CONS OF dividend investing cover

Dividend Investing: Pros and Cons That You Should Know

One of the most popular ways to generate income from stocks is dividend investing. Here, the investors enjoy the benefits of dividend income along with capital appreciation.

Anyways, if you are new to dividend investing, let me give you a brief introduction.

Dividends are basically a portion of income that a company distributes to its shareholders. Dividend investing means investing in those stocks which give high consistent dividends to their investors.

For example, in the last financial year (Mar 2018), HPCL gave a dividend of Rs 17 per share to its shareholders (Dividend yield=3.8%). Therefore, if you were holding 100 shares of HPCL company in your portfolio 2018, you would have received Rs 1700, credited directly into your bank account without selling even a stock.

A lot of equity investors invests in stocks just for the dividends. Dividend investing is a good way to earn secondary income along with enjoying the capital appreciation for your invested stocks. When invested correctly, investors can earn amazing income through dividends. (Also read: How to make money from dividends- the right way?)

In this post, we are going to discuss the pros and cons of dividend investing that you should know before making your investment in dividend stocks.

Pros of investing in Dividend Stocks:

Let’s start with the pros. Here are a few best advantages of investing in dividend stocks:

1. Passive Income:

This is probably the biggest advantage of investing in dividend stocks. You can treat dividends as a passive income- which means getting paid without doing any work. For the people looking for a few alternate secondary sources of income, dividend investing is the answer.

Anyways, for making passive income through dividend investing, initially, you need to put big efforts to find good dividend stocks. However, once the work is done, you can enjoy the passive income for multiple years.

2. Double Profits:

If your invested stock goes up by 30% in the next 3 years, and you received a dividend yield of 3% per year from the same stock, the combined profits are way higher than just the capital appreciation. Here you can earn double profits compared to investing in companies that don’t give any dividends.

3. Hedge against bad markets:

Everyone makes money in a rising market. However, the scenario is different when the market turns sour.

In the bear market or corrections, the share price of a lot of your favorite stocks may fall. And hence you might not be able to make a good return from capital appreciation of stocks. However, if you have picked right dividend stocks in your portfolio, you can enjoy a decent dividend income even when your portfolio is down.

Further, dividend stocks are generally big matured companies and hence are less influenced by a bear or speculative market. Investing in these companies can provide a good hedge to your investment from a bad market. In addition, dividend investing also helps in capital preservation. Even if the stock price of your invested company doesn’t go up, if you are getting regular high dividends, you will be able to preserve your capital.

4. Steady Income:

Profits from stocks are only on ‘paper’ unless you sell them. This money is not in your bank account. The profits/loss are unrealized until the final settlement i.e. selling the stock. However, dividend stocks add steady income in your pockets without worrying about selling any stock.

5. Dividend Reinvestment:

You can use the dividends that you receive from stocks to buy more stocks and reap the benefits of dividend reinvestment. Else, you can use that money to invest in any alternative investment options like Bonds, gold etc if you want to diversify your portfolio. Once you get the money back in your account, you have immense options to re-invest them back in whichever investment option that suits you.

6. Long-term investment: 

One of the best strategies to make money from stocks is the same old philosophy of ‘buy and hold’. However, while investing for the long term, there may be a number of situations where the investors may be in the need of a few extra bucks. Here, selling stocks may be the only option available to them if they want to make money from their invested stocks.

Nevertheless, as dividend stocks offer a steady income stream, investors may prefer to hold the stocks longer and enjoy the benefits of long-term investing.

stock market meme 31

Cons of investing in dividend stocks:

No investment strategy is perfect and the same goes with dividend investing. Here are a few biggest disadvantages of investing in dividend stocks:

1. Low-growth companies

Most growth companies do not give dividends to their shareholders as they reinvest their profits in expanding their businesses like opening new plants, entering new cities, buying new machinery, acquiring small companies, etc.

On the other hand, big matured companies do not have so many opportunities and hence they offer a large profit to their shareholders. While investing in dividend stocks, the investors may be investing in low growth companies which may not always offer high returns.

2. High dividend payout risks

High dividend payout means that the company is distributing a major portion of their profits to their shareholders. For example, if a company made a profit of Rs 100 crores in a financial year and shares Rs 85 Crores as dividends, this means that the dividend payout ratio is 85%.

At first glance, it may sound favorable for the shareholders. After all, they are getting a major portion of the profit as dividends. However, in the long run, it may not be advantageous for investors.

Think of it from the other angle. When the company is not retaining enough profit for itself, it doesn’t have any big money left for reinvesting in its growth. And if the company is not reinvesting enough, it may face problem to grow, compete with the rival companies or even to retain the same net profit in upcoming years. Moreover, if the company doesn’t grow or increase its profits, it can’t add more value or increase dividends for the shareholders in the future.

3. Double Taxation

Companies pay Dividend distribution tax (DDT) of 15% to provide dividends to their shareholders. However, once dividends are credited to the shareholders, the investors again have to pay a tax on the capital gain. Although, small investors do not have to pay any tax on dividends. However, if the dividend received is more than Rs 10 lakhs, the investor has to pay a tax of 10% on the capital gain by dividends.

Also read: Do I Need to Pay Tax on Dividend Income?

4. Dividend cut

This is the worst case scenario. Dividends are not obligations and a company may decide to cut the dividends anytime in the future. Moreover, when the company cuts the dividends, even the share price falls significantly as the public sees it as a negative sign. And that’s why the dividend investors may face double side trouble.

Further, many times, the board of directors can also change the dividend policy of a company. This can again have an adverse effect on the dividend investors if the decision is made against the existing dividend policy.

stock market meme 23

Quick Note: New to investing? Check out this awesome investing course for beginners: HOW TO PICK WINNING STOCKS? Enroll today and start your journey in the exciting world of the stock market.

When you should exit a dividend stock?

Now, that you have understood the pros and cons of dividend investing, the next big question is when should you exit a dividend stock. If you’ve invested in dividend stocks, look for the following signs periodically to avoid any dividend pitfall in your invested company. Here are the three signals that you should exit a dividend stock:

— Dividends start declining: A fall in dividend for a year compared to the previous one can be ignored by the investors as businesses can always have a few losses in some years. However, if the dividends start continuously declining year-after-year, it may be a sign for the investors to exit.

— High dividend payout: A payout ratio greater than 70% for the continuous years may be a warning sign that the company is not retaining enough profit for its growth.

— An adverse change in dividend payout policy: If the company changes its dividend policy against the favor of the investors, then again it may be a sign to exit that stock.

Closing Thoughts:

Traditionally, dividend investing approach was used by the retirees or the people entering their retirement age. As these people do not have any primary source of income (regular paycheck) after retirement, receiving small dividends per year in their account can be a good secondary source of income.

However, these days even the young and middle-aged investors are looking forward to dividend investing. Why? Because it is always a joy to see dividends get credited to your account periodically. Moreover, they do act as a secondary income source.

That’s all for this post. I hope it was helpful to you. Happy Investing.

Dividend stocks- Should you invest in it?

Dividend stocks: Should you invest in it?

Dividend stocks: Should you invest in it?

Hi Investors. In this post, we are going to discuss dividend stocks and should you invest in it?

Dividends are one of the most debatable topics while picking a stock. While many consider high regular dividends as a healthy sign for a company, on the other hand, many think that giving high dividends are counterproductive for a company.

Therefore we will discuss all the prospects of dividend stocks in this post. Whether they are good or bad for an investor?

Here are the points that we are going to cover in this post.

  • What are dividends?
  • Important terms that you should know regarding dividends
  • Why some companies give dividends and other don’t?
  • Why dividend matters for investors?
  • Common misconceptions to know about dividend stocks.
  • Should you invest in dividend stocks?

So, let’s get started.

What are dividends?

Whenever a company has a profit, it can either pass it to its shareholders or reinvest that profit in its business.

The profits that the company shares with its shareholders are called dividends.

Dividends are the corporate earnings that companies pass to their holders to reward them.

Companies can give dividends to their shareholders multiple times in a year. However, most of the companies give dividends twice a year- Interim and final dividend.

Also read: 7 Best Stock Market Apps that Makes Stock Research 10x Easier.

Important terms that you should know.

Here are few financial terms that you should know regarding dividend stocks.

Dividend yield: The dividend yield is the dividend per share, divided by the current share price. It indicates how much a company pays out in dividends each year relative to its share price.

Payout ratio: The dividend payout ratio is the amount of dividends paid to stockholders relative to the amount of total net income of a company. 

The amount that is not paid out in dividends to stockholders is held by the company for growth and is called retained earnings.

dividend yield

Why some companies give dividends and others don’t?

In general, growing companies don’t give dividends whereas mature financially strong companies which do not have much scope to grow or to reinvest the profits, give dividends to their shareholders.

When the company is still growing, they invest their profits in growth. The profit amount can be used in business expansion, new project, acquiring a new company, share repurchase, etc.

Even large companies that can grow, reinvests their money and does not give dividends.

Few sectors which are saturated and give big dividends to its shareholders are PSUs, utility industry, etc. For example- Coal India, HPCL, BPCL, NHPC etc.

Why dividend matters for the investors?

If the investors are getting regular increasing dividends, this is a powerful message of efficient management and good financial health of the company.

Dividends are big commitments and are considered as a promise to the public.

When a company’s management pays a dividend to its shareholders, its a serious commitment as the company tends to give regular (increasing) dividends in future. This also shows the confidence of the company in its future performance.

Dividends are also the returns that many investors rely upon for their future plans like retirement funds, without selling their stocks.

Common misconceptions to know about dividend stocks:

  • Dividend stocks are financially strong companies:

Although most of the dividend-paying companies are mature and financially strong, however, there are few who aren’t.

There have been cases where the companies are taking debt to maintain the regular dividends to the shareholders. The investors might think that the company is giving a regular dividend and must be financially healthy, however paying dividends on debts is a terrible signal for the investors.

Also read: 8 Financial Ratio Analysis that Every Stock Investor Should Know

  • Dividend stocks are safe investments:

There are few companies which are paying high dividend yield, however, can’t be considered as a safe investment. These companies have saturated and there is not much growth left in their Industry. 

If you are planning to buy such stocks for long-term (retirement plan), then the company might not be profitable by then.

For example- Coal India. The company gives a healthy dividend. However, there is very little possibility of growth in this industry, and in the next 20 years, the company might won’t even be in any profit to reward its shareholders with dividends.

  • High yield is good for dividend stocks:

Dividends are the cash that is paid out to the customers and hence, this amount never gets reinvested in the business. A high dividend is good for your portfolio until the payout ratio is high.

If the payout ratio is large, this means that there is not much growth option for the company, and that’s why the company is giving all its profits to its shareholders in place of reinvesting the profit.

Dividend stocks can only be considered value stocks if you can find a high yield stock with a low payout ratio (<50%). Such companies are maintaining a healthy balance between reinvesting and rewarding its shareholders and thus, tends to offer high returns.

  • Dividend stocks are from boring sectors:

As a general scenario, most of the PSUs, utility company etc give high dividends to their shareholders and belong to a slow growth / saturated industry. Hence, dividend stocks are considered to be boring. 

However, there are many stocks who give high dividends to their shareholders and belong to a growing industry.

Should you invest in dividend stocks?

If you are planning to play safe and want some regular income (without selling your stocks) along with the capital appreciation in your investments, then dividend stocks are a good option for you.

However, if you want high returns and are willing to take some risks, do not invest in dividend stocks.

Although, you won’t get a dividend in growth stocks, however, the capital appreciation will be large enough to compensate for the dividend yield.

Nevertheless, if you are getting any dividend in the growth stocks, you can sleep well. Dividend matter, even for the growth investors.

Also read: Why do stock prices fluctuate?

Conclusion:

Dividend stocks are not a wealth creator. However certainly, they are a reliable source of earnings.

Now, in case you are looking to invest in dividend stocks, make sure that the company is fundamentally strong.

Dividends are only paid when the company is in profit.

In case you didn’t pick a fundamentally strong company, and it didn’t perform well in future (i.e. no profits), then you won’t get any dividends. In such a scenario, even the basic reason for your investment will fail.

Bottom line, it totally depends on your investment goals and preference to whether you should invest in dividend stocks or not. Nevertheless, it’s good to have a few dividend stocks in your portfolio for some consistent earnings.

Also read: How to Invest in Share Market? A Beginner’s guide

That’s all. I hope this post about ‘dividend stocks’ is useful to the readers.

In case, you have any doubts, feel free to comment below. Happy Investing.