How To Make Money From Dividends -The Right Way?

Everyone who enters the stock market wants to make money from their investments. And in order to do that, first, they need to understand how people really make money from stocks. Basically, there are two ways to make money from the stock market – Capital appreciation and making money from dividends.

When it comes to capital appreciation, most of the people know this method to make money from stocks. Buy low and sell high. Purchase a good stock at a low valuation and wait until the price goes up. The difference in the purchase and selling price is the profit (capital appreciation).

This is the core principle of value investing. Find an amazing stock at a cheap valuation and hold it for a long time until the market realizes its true/real value.

However, there is also a second method to make money from the stock market which is (generally) ignored by most newbie investors. It is called dividends. In this post, we are going to discuss how to make money from dividends -the right way.

Important terms to learn regarding dividends:

Before we dig deeper, first you need to learn few important terms regarding dividends-

Dividends: Dividends are the profits that a company shares with its shareholders as decided by the board of directors.

Dividend yield: Dividend yield is the ratio of annual dividend per share divided by the price per share. The formula for dividend yield is given below:

Dividend yield = (Dividend per share/ price per share)

For example, if a company gives an annual dividend of Rs 10 and its current market price is Rs 200, the dividend yield of the company will be 10/200 = 5%.

Here are the annual dividends of a few famous companies in India (2017).

• Hdfc bank – Rs 11 per share
• Coal India – rs 19.90 per share
• Hindustan Unilever – Rs 17.00 per share
• Reliance Industries- Rs 11 Per share
• Ongc- Rs 6.05 per share

Now, if you calculate the dividend yield given by the above companies, you may find it very small.

If a company gives a dividend yield of 2% per year, it’s really difficult to build a livelihood using this income, right? For example, if you want an annual income of Rs 2 lakhs in dividends, then you have to invest Rs 1 Crore in that stock. This is not feasible for most of the average Indian investors.

However, there’s an important lesson that you need to learn here—

Dividends increase over time…

This means that a good fundamentally strong company will increase its dividends with time.

For example, if a healthy company gives a dividend of Rs 10 this year and makes more profit in upcoming years, then it will increase its dividends in future.

Another important lesson to learn here is that– your dividends are going to increase. But your purchase price is going to remain constant throughout your holding time frame.

Therefore, if you look at the dividend yield, the numerator (dividends) is going to increase with time. But the denominator (purchase price of the stock) is going to remain constant for you. In short, the dividend yield for that stock is going to increase in future.

Let us understand this better with the help of an example.

How To Make Money From Dividends?

Suppose you purchased 100 stocks of a company at Rs 200. The annual dividend for that year was Rs 10. So, for the first year, the dividend yield will be 5%. This yield is small here compared to the returns from most of the debt investments.

Nevertheless, let us assume that the company is fundamentally healthy and going to give a consistent (increasing) dividends in the upcoming years. Here is a table describing the annual dividends in the upcoming years.

 Dividend Purchase Price Dividend Yield Total Annual Dividends YEAR1 Rs 10 Rs 200 5% Rs 1,000 YEAR2 Rs 12 Rs 200 6% Rs 1,200 YEAR3 Rs 15 Rs 200 7.5% Rs 1,500 YEAR4 Rs 18 Rs 200 9% Rs 1,800 YEAR5 Rs 21 Rs 200 10.5% Rs 2,100

Moreover, along with the dividends, your capital will also appreciate in value as you are holding the stock for a long time. In the next 5 years, maybe the purchase price of Rs 200 has now appreciated to Rs 400, 500 or whatever high price.

For the investors, who buy that stock directly in the fifth year (at an appreciated price- let’s say Rs 500), the dividend yield for them might be low. However, as you have purchased that stock long ago at a decent price, the dividend yield will be quite high (even higher than the fixed deposits). From the above table, you can notice the increase in the dividend yield as the dividend increases.

In short, here dividends are allowing you to receive a healthy income without selling your original assets.

Also read: New to stocks? Confused where to begin?  Here’s an amazing online course for beginners: ‘HOW TO PICK WINNING STOCKS?‘ This course is currently available at a discount.

A few points of concerns regarding dividends:

The biggest point of concern regarding dividend stocks is that dividends are not obligations. This means that the company may reduce or discontinue the dividends in future.

For example, if a company suffers a heavy loss in a year or if the company is planning to invest its profit in some new project/plant, then it might reduce the dividends or do not give any dividends to its shareholders.

Therefore, if you are investing in any dividend stock, then first make sure to look at the dividend history of that company. A consistently increasing dividend for the last 10-12 years can be considered a healthy sign.

Conclusion:

Buy low and sell high is not the only way to make money from the stocks. There are many long-term investors who are generating big wealth through their annual dividends. If you want a good consistent return on your stocks without selling it, then investing in a healthy dividend stock can be a good strategy.

That’s for this post on how to make money from dividends. I hope it was helpful to you. Have a great day and happy investing.

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.

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.

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.

• 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.

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.