What do we actually understand by high dividend yield stocks? Dividend yield is calculated by dividing the rupee dividend paid by the company during the year by the latest stock price. In India some stocks have been typically high dividend stocks. What are the benefits of dividend stocks? Should I invest in dividend stocks? The bigger question; are dividend stocks worth it? Before we carve out a dividend investing strategy, let us first understand what is dividend yield with a live illustration of 10 Indian companies with dividend yields in excess of 5% annualized?
Understanding the dividend yield concept..
Company NameDividends FY-17 (Rs.)CMP – 08th Mar (Rs.)Dividend Yield (%)Sutlej Jal Vayu Nigam2.7532.908.36%Hindustan Petro30.00360.858.31%REC9.65125.757.67%PNB Gilts2.5035.607.02%Bharat Petroleum31.00442.407.01%NHPC1.8026.656.75%Coal India19.90305.906.51%Vedanta19.45308.406.31%Chennai Petro21.00343.806.11%Power Finance5.0091.855.44%
The list above includes some of the high dividend yield stocks in the Indian markets. It is hard to put a cut-off for dividend yield but normally a dividend yield of above 5% in the Indian context is considered to be high dividend yield. So what are the benefits of dividend stocks? Here are 3 such advantages..
Dividend yield is a good investment idea if you are looking at regular income in the form of dividends from stocks. More so when the dividend yields are more than the yields on debt then there is an additional case for investing in dividend yield stocks.
Dividend yields act as a base below which the price of a stock does not fall. More often than not, the dividend yield of around 5-6% acts as a price support for the stock as below that price the dividend yield becomes too attractive and invites buyers.
Dividend yield stocks are attractive in post-tax terms since dividends are tax exempt in the hands of the investor. Of course, effective the Union Budget 2016, there will be a 10% dividend tax if your annual dividend exceeds Rs.1 million. But that still keeps most small and middle level investors outside the ambit of tax.
Do high dividend yield stocks outperform other stocks?
There can be no definitive answer to this question. However, let us look at the total returns index of 3 different indices to get a better idea. What do we understand by the total returns index? Normally, index returns are calculated on a point-to-point basis and does not consider the dividend. In the Total Returns Index (TRI), the dividend yield stocks have an advantage as they have a dividend advantage over the Nifty and the Mid Cap index. Here we have considered the TRI of 3 indices for the last 1 year between March 2017 and March 2018.
ParticularsNifty IndexMid Cap IndexDividend Opportunities Index1 year returns15.31%20.59%15.87%
It can be seen from the above analysis that if you consider the Total Returns Index (TRI) then the Dividend Yield Index has performed at par with the Nifty although it has underperformed the Mid Cap Index.
Are there are any arguments against the dividend yield approach to investing?
Typically, the dividend story is not exactly a favourite among institutional and small investors due to 5 key reasons. Let us understand why the dividend investment strategy does not exactly work as an investment approach?
Normally, dividend yield stocks are low growth stocks and the market is always willing to give a higher P/E ratio for growth stocks than regular income stocks. Therefore, dividend yield stocks rarely see re-rating of the P/E ratio.
A high dividend yield stock is seen as a company that has limited investment opportunities in the business. Since equity investors invest in the business, this bleak growth outlook clouds their valuation.
Globally and in India, high dividend yield stocks tend to be in sectors like utilities and commodities trading which are not exactly high growth stories. Normally, investors put money in these sectors purely for the regular flow of dividends only.
Most investors see dividends as partial liquidation of business. Typically, companies have two choices in front of them. They can either pay out more of their profits as dividends or they can plough back their profits into reserves. When the company pays out dividends it reduces the value of the business to that extent.
When a company pays out dividends, there are 3 levels of taxation involved. Firstly, there is the reality that dividends are a post-tax appropriation and hence there is no tax shield. Secondly, when the company declares dividends there is a dividend distribution tax (DDT) that is imposed on the company, which reduces the dividend payout. Lastly, the 10% tax on dividends above Rs.1 million also reduces its attractiveness.
The moral of the story is that markets do not prefer high dividend stocks as they generally tend to be low growth stocks in saturated industries. That is not the recipe for creating wealth in equities.