When do companies pay high dividends?
In this blog, we will discuss what is dividend yield, top 5 high dividend yield stocks and whether or not one should invest in these stocks.
Dividend yield vs Dividend Rate
- Dividend yield is basically a financial ratio which is the cash dividends paid out by the company as a percentage of its stock price. Thus, dividend yield is given as cash dividend/ stock price (D/P).
- On the other hand, dividend rate is calculated as a % of face value. Thus, it is given as cash dividend/ face value (D/FV).
- Let us understand this with the example of ITC Ltd. We recently heard that ITC Ltd announced dividend rate of 1025% . Let us calculate the actual dividend amount and dividend yield of ITC Limited.
- We know the face value of ITC Ltd is INR 1, hence the dividend given by ITC is INR 10.25. Now, when we divide this dividend amount by its current stock price( i.e INR 200), we get the dividend yield. Thus dividend yield of ITC limited is (10.25/200) 0.05 or 5%.
- Dividend yield gives a clearer picture of effective dividends in the hands of an investor as compared to dividend rate.
Dividend distribution tax
- Earlier, companies used to pay the tax associated with dividends before distributing them. The dividend distribution tax paid by companies used to be ~20%.
- However, from this year, as mentioned in the annual budget, dividend distribution tax will be applicable to shareholders instead of companies.
- This tax will be applicable according to shareholder’s tax brackets. Thus, if a shareholder comes in lower tax bracket of 10-20%, it is advisable for him/her to invest in high dividend yield stocks.
Top 5 high dividend yield stocks
- All these companies belong to PSU sector. These are cash flow rich companies with sound business.
- However, the problem is that these companies do not have significant growth opportunities available.
- Even if in some cases ,they have some growth opportunities available, being PSU companies they have the obligation to pay hefty dividends.
- Usually companies pay heavy dividends when there are not many growth opportunities available for the companies to expand.
- That is why instead of retaining and reinvesting the profits , such companies prefer paying out profits in the form of dividends to the shareholders.
- Thus, company having higher dividend yield indicates that it does not have much growth avenues currently.
- Shareholders can benefit by investing in these companies by receiving higher dividends, however there will be limited capital appreciation in terms of share price.
Should we invest in these stocks?
- This entirely depends upon the risk profile of investor. If an investor finds it alright to earn higher dividend but compromise on capital appreciation, he/she should invest in high dividend yield stocks.
- These company’s price movements are quite range bound and can be tracked by following technical analysis and hence, traders usually prefer these companies.
- However, we suggest that a retail investor should stay away from trading and instead focus on longer term investing.
What is Yadnya’s view on investing in these stocks?
- We do not prefer to invest in these stocks. At least not for the sake of earning heavy dividends. We prefer capital appreciation as opposed to earning higher dividend yields.
- We prefer companies with modest dividend yield (~1.5%) but greater growth avenues in which the companies can reinvest the profits.