Introduction

Dividend stocks are now popular among Indian investors hunting for reliable returns, especially in a world of uncertainty. However, it can be detrimental when investors let these myths affect their choices when buying dividend stocks. This article will discuss three myths around dividend stocks, help clarify what a dividend is in the share market, and provide some thoughts for Indian investors to make better decisions while seeking the best dividend stocks.

What is a Dividend in the Share Market?

Before we explore the myths, let's explain: What is a dividend in the share market? A dividend is the part of a company's profit distributed to its shareholders. Companies usually pay dividends in cash or shares. In India, it is standard for companies like Hindustan Unilever, ITC, and Reliance Industries to pay dividends to their investors. Dividends can also be expressed as a per-share amount or as a percentage, known as a dividend yield. The dividend yield is calculated as the annual dividend divided by the price of the shares. For example, if a company pays a yearly dividend of ₹10 per share and the share price is ₹200, the dividend yield would be 5%. Ensuring you understand this concept is key to differentiating between myths about dividend stocks.

Myth 1: Dividend Stocks Are Only for Retired Investors

It is a widespread misconception that dividend stocks are primarily meant for retirees or those looking for additional cash flow in their sixties and seventies. This misconception has arisen because people think of dividends as reliable income for someone who is not working.

For young investors, dividend stocks get the rewards of the compounding process. When dividends are reinvested into that histogram by buying more shares (either via Dividend Reinvestment Plans or even manually), the investor uses the purchasing power of dividends to build their stock portfolio over time. For example, the best dividend stocks, such as Tata Consultancy Services (TCS), with a long history of paying dividends, were purchased. In that case, the investment will dramatically value-enhance when viewed over a few decades.

Most dividend-paying stocks are large, established corporations in sectors like fast-moving consumer goods (FMCG) or banking and are relatively less volatile to the market cycles within India. So, whether you are a 30-year-old Information Technology (IT) professional in Bengaluru or enjoy retirement in Mumbai, dividend stocks can be invested in with any financial investment goal.

Myth 2: Dividend Stocks Always Outperform Non-Dividend Stocks

Another widely accepted belief is that dividend stocks outperform non-dividend-paying stocks consistently and are a sure bet. While dividend stocks frequently give steady returns, this is not always the case everywhere, particularly in India's volatile markets.

According to some historical benchmarking examples such as the National Stock Exchange (NSE) where dividend-paying companies significantly outperform non-dividend paying companies over an extended time, e.g., sometime after a 3-4 period, the company has decreased in value to reap the earlier dividend payments or the dividend yield of the companies being studied paid dividends to their stockholders.  Growth companies like tech startups or small-cap companies outperform dividend stocks in bullish markets. For example, during the software boom in India, Zomato, a non-dividend-paying company, has seen a considerable increase.  Whether in bearish or sideways markets, dividend stocks will outperform non-dividend paying stocks, as the dividend returns provide income and, in bad times, if the stock is low enough, it may provide some downside protection against losing all your capital.

Myth 3: All Dividend Stocks Are Safe Stocks

Many investors categorise all dividend-paying stocks as low-risk due to their typical income payment, regardless of whether the stock price increases. These misguided assumptions can lead to risky investment outcomes.  While some dividend-paying companies are not financially liquid and do not generally produce net profit for their shareholders, some have lost generations of profits. On the contrary, other stocks with high dividend yields indicate that the company may struggle to maintain profitability, and their business policy is to pay out their earnings.

A good dividend yield may look enticing, for instance, a company offering a 10% yield, but if that company's payout ratio (dividends as a percentage of earnings) is above 80-90%, for example, more than 80-90% of their profits are being paid out in dividends, they may have trouble making those payments. In India, we often see sectors like public-sector banks or utilities, offering dividend yields much higher than 10%, but when investing in them, one needs to look at the fundamentals.

Conclusion

Dividend stocks are a hedge for Indian investors. By investing in dividend stocks, there's a possibility of income, stability, and the potential for capital gains. So, myths in the investing world led to investors sometimes misunderstanding that dividend stocks can and should play both an income-generating role and an eaffective investment for those building wealth. By understanding a dividend or dividend payment in the share market and through researching, you can choose some of the best dividend stocks and use them to build wealth. In that case, if you keep a disciplined investing strategy for dividend stocks, you will be able to go toward achieving your financial goals.

Related Blog - About Dividend Paying Stocks