In India, young investors are typically focused on growth to build wealth. But as retirement approaches, many look towards building a dividend portfolio for its steady income stream. Ready to Get Started? Let’s Become Awesome in Dividend Investing!
The Context
The Indian stock market, with its key indices SENSEX (1986) and NIFTY (1996), is relatively young compared to giants like the US S&P 500 (dating back to 1923). This lack of multi-generational experience can sometimes lead to a focus on short-term gains, influenced by the altered expectations from the fast world we live in (think 30-minute pizza delivery!).
This mindset overshadows the benefits of dividend investing; a strategy more popular in mature markets like the US, especially among retirees seeking steady income. However, dividend investing offers advantages even for younger investors. It allows you to learn the market ropes while potentially buying quality stocks at lower prices during downturns.
This article reveals ten essential facts you need to know to become a successful dividend investor in India, even if you’re just starting out!
10. Investment for Desired Dividend Income Formula
Have a target income amount in mind for your dividends? Let’s explore how much to invest to reach that goal!
While some financial experts and social media entertainers make this calculation seem like magic to achieve your desired income through dividends, it’s quite simple maths.
The key steps involve first determining your target dividend income, which is the yearly amount you hope to receive. Then, you’ll need to research the historical dividend yields of stocks that interest you. This yield represents the percentage of a stock’s price that’s paid out as dividends. Once you have this information, a simple formula can be used to calculate the investment amount needed to reach your income goal based on the chosen stock’s dividend yield.
Investment Amount= Target Dividend Income / Stock Dividend Yield
For example, let’s say you want to receive Rs. 10,000 per year in dividends and you’re considering a stock with a historical dividend yield of 5% (0.05) like Coal India Ltd.
Investment amount = Rs. 10,000 / 0.05 = Rs. 200,000
This means you would need to invest Rs. 200,000 in that particular stock to generate Rs. 10,000 in dividends annually (based on the 5% yield). Do note though, that a stock’s historical yield is a good starting point, but the actual payout may vary in the future.
9. Be Mindful of Tax Implications on Your Dividends
While keeping your money invested for long-term growth is ideal, dividends can be a source of regular income.
However, remember that dividends are now taxed in India based on your income tax slab. This means you’ll pay taxes on the dividend income you receive, potentially reducing the compounding effect of reinvesting them.
Besides, when it comes to TDS on domestic dividends, companies now deduct TDS (Tax Deducted at Source) at 10% on dividend income exceeding Rs. 5,000 in a financial year.
Foreign dividends are also taxable, with a specific rate depending on Double Taxation Avoidance Agreements (DTAA) with the foreign country. TDS typically applies at 20% for foreign dividends. Read more about DTAA in our previous write-up on US investing.
8. You Can Value Dividend Stocks with Dividend Discount Model (DDM)
Dividend Discount Models (DDMs) take a unique approach to valuing stocks. Unlike methods that focus on future growth or current price, DDMs prioritize the cash flow an investor receives through dividends.
The core idea of DDM valuation is based on a simple principle – project how much a company will pay out in dividends over time (future dividends), and then consider the time value of money by discounting those future dividends back to their present value (a rupee today is worth more than a rupee tomorrow).
While DDMs have limitations, like predicting future dividends and choosing the right discount rate, they offer a valuable framework for investors seeking income. They help analyze stocks based on their potential to generate a steady stream of income through dividends.
Ready to master DDM valuation? Explore our online resources!
7. Let’s Be Mindful of the Ideal Dividend Yield Expectations
While some stocks may boast very high dividend yields (especially during market downturns), it’s important to consider realistic expectations. A good range to target is typically around 4-5%. Why you would ask?
It’s because companies with a long history of high payouts are usually mature and stable, but their growth potential might be limited. While this plays out well for an investor who is nearing retirement and wants to stabilize overall portfolio yields, this may become a deterrent for young salaried investors.
Also, if you have a long investment horizon (typically 10-20 years), it is advisable to consider companies with a history of increasing dividends alongside some potential for capital appreciation (stock price growth) along the way.
6. Never Confuse Current Yield with Effective Yield
When evaluating dividend stocks, a standard metric like current yield can miss the whole picture for long-term investors.
The current yield is based on the stock’s current price, which may not reflect what you paid for it. The effective yield on the contrary considers your cost basis, or the price you bought the stock at. This gives a more accurate idea of your return on investment.
For example, imagine a stock priced at Rs.100 with a Rs.10 dividend (10% current yield). If you bought it years ago for Rs.75, your effective yield is 13.3% (Rs.10 dividend / Rs.75 cost basis).
5. More Than 100% Payout Ratios Can Be Potential Red Flags
Companies use dividends to share profits with shareholders. While these payouts don’t always come directly from earnings, a company can’t keep giving out more money than it makes.
This is where the payout ratio comes in. It shows how much of a company’s earnings (typically per share) goes towards dividends (also per share) over a year. Now, imagine a company earns Rs. 1 per share and pays a Rs. 0.70 dividend. The payout ratio is 70% (looks healthy!). A Rs. 0.10 dividend would mean a 10% payout (looks conservative).
But what if the dividend is Rs. 1.20, leading to a 120% payout ratio? This raises a red flag. How can the company keep paying more than it earns? While some companies, especially in steady industries, might maintain consistent dividends despite fluctuations, a payout ratio exceeding 100% for long periods is generally unsustainable.
4. Ex-Dividend Dates are Important to be Eligible for Dividends
The ex-dividend date is like a cutoff point. If you buy a stock on or after that date, you won’t get the next dividend payment. That’s because the stock price typically drops by the amount of the dividend on the ex-dividend date.
Want the dividend? Buy before the ex-dividend date.
To be eligible for the upcoming dividend, you must own the stock by the day before the ex-dividend date. Check the BSE or NSE websites for the latest ex-dividend information.
These websites can help you stay on top of important dates for dividend-paying stocks.
3. Dividend Frequency In India Varies Throughout the Year
In contrast to the consistent dividend schedules (quarterly or even monthly) seen in some US companies, Indian firms distribute dividends at variable intervals, with one annual payout before their financial books close in March.
The first type of dividend, the interim dividend, is announced based on a company’s performance over a quarter or half-year and occurs before the Annual General Meeting (AGM) and earnings announcement.
Unlike the final dividend, the interim dividend can be canceled or modified by the company after it’s been declared. The final dividend, on the other hand, is the annual announcement based on the entire year’s performance and is declared alongside the company’s results. Importantly, once announced, the final dividend cannot be withdrawn by the company.
2. Please Mind Industry Specific Factors for Dividend Sustainability
High dividend yields can be tempting, but not all companies are created equal. Some sectors, by their nature, tend to pay out more of their profits as dividends.
Utilities and commodity companies, both globally and in India, are known for their reliable dividends. These companies, like Coal India Ltd or Hindustan Petroleum Corporation Ltd in India, are often well established with mature infrastructure and predictable business models. They may not be high-growth companies anymore, but their stability allows them to distribute a larger portion of their earnings as dividends to shareholders.
The reason? Over time, these companies have reached a stage where they don’t need to reinvest as much profit back into the business for growth. Their infrastructure is built, their customer base is established, and they have a good handle on supply and demand. This frees up more cash for them to pay out to shareholders.
Now, companies in sectors like technology (Infosys Ltd, HCL Technologies Ltd, Tata Consultancy Services Ltd) or construction (Oberoi Realty Ltd, DLF Ltd) are typically focused on growth. They’re constantly reinvesting profits to expand their reach and develop new products or services. So, if you see a tech or construction company offering a very high dividend yield, it could very well be a red flag.
The company might be struggling to reinvest profits back into the business for future growth. This could be a sign that their expansion has slowed down. Or the company might be prioritizing short-term gains over long-term growth. By offering a high dividend, they might be trying to attract investors and inflate their stock price.
1. Understanding Dividend Yield is Crucial for all Dividend Investors
We see a lot of investors getting confused about dividend yields so, let’s break it down for the sake of simplicity.
Imagine owning a piece of a company (that’s what a stock is!). Now and then, the company might share some of its profits with its owners (could be you!) in the form of a cash payment called a dividend. It’s like a little bonus for being an investor.
Now, dividend yield measures the return on investment from dividends relative to the stock’s current price. It’s calculated by dividing the annual dividend per share by the current price per share. Although dividend yields can decrease when stock prices rise, those who already own the stock benefit from a higher personal yield based on their purchase price.
Here’s the catch though, when stock prices rise (like during a bull market), the dividend amount usually stays the same. So, while the company isn’t paying out less, the stock becomes more expensive. This means the dividend yield goes DOWN for new investors buying at the higher price.
However, if you already owned the stock before the price went up, your personal dividend yield isn’t affected! You’re still getting the same dividend on a lower purchase price, so your return is better.
Conclusion
Dividend investing offers a viable strategy for generating income, especially as investors transition from accumulation to income phases in their investment journey. With the right approach and knowledge of key facts, you can effectively integrate dividend investing into your overall strategy.
Give dividend investing a try. While doing so, the ten must-know dividend investing facts you just learned can help you build a great foundation.
We hope you enjoyed this informative piece at PlanB Financials. Remember, we are here to brush you up for success in your proprietary investment journey. For those seeking additional guidance, we recommend consulting a registered financial advisor.
Frequently Asked Questions (FAQs)
1. Why is dividend yield important, and how does it impact my investment?
Imagine you own a slice of a company, and they decide to share some of their profits with you as a sweet bonus – that’s a dividend! Now, the dividend yield helps you measure the “bang for your buck.” It tells you the percentage of the stock’s current price you’d get back each year in dividends. Always check it out to ensure you’re getting a good deal.
2. How do industry-specific factors play a role in dividend sustainability?
Not all companies are cut from the same cloth when it comes to dividend investing. Some sectors, like utilities and commodities, are like reliable friends who always have your back. They’re known for stable dividends because they’ve reached a chill stage where they don’t need all their profits for growth. On the flip side, if a high-dividend tech company is screaming for attention, something fishy might be going on.
3. Why is dividend frequency in India different, and when can I expect those payouts?
Unlike the clockwork dividend schedules in some US companies, Indian firms like to keep you on your toes. They throw out dividends at varying intervals, with one grand annual reveal before closing their financial books in March. Know the difference between interim and final dividends to stay in the loop.
4. What’s the deal with ex-dividend dates, and why should I even care?
Picture the ex-dividend date as the party cutoff. If you stroll in or after that date, no dividend for you! The stock price usually drops by the dividend amount on this day. To snag that cash, make sure you’re a stock owner before the ex-dividend date. Keep an eye on BSE or NSE websites to stay on top of the dividend game. Company websites are also a great source of details.
5. How can more than 100% payout ratios be a red flag?
Companies can’t pull off magic tricks – they can’t give out more money than they make. Enter the payout ratio – it shows how much of a company’s earnings goes towards dividends. If the payout ratio exceeds 100% for too long, it’s like a financial SOS signal. Steer clear of companies playing with fire.
“This information is for educational purposes only and should not be considered investment advice.”
