“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in”
- John D. Rockefeller, one of the wealthiest individuals of all time.
A great source of passive income for investors comes from the source of dividends that companies offer. It is, therefore, no surprise that many investors who call themselves dividend investors wait eagerly for their dividends to come into their bank accounts. In this article, we shall cover what exactly are dividend stocks, how to identify dividend stocks, important factors to look for while selecting these stocks and how to buy these dividend stocks.
What are dividends and dividend stocks?
After much of its growth stages, corporations find themselves unable to expand their business or reinvest their additional profits into newer businesses. When they reach this stage, these corporations can choose to share their profits with their shareholders. The amount that shareholders receive is known as a dividend, and publicly listed companies in a stock exchange that offer dividends are referred to as dividend stocks.
The dividend amount is decided on an amount per share rate and is decided by the board of directors depending on the net profit of the company. For example, if you own 20 shares of Company X and the board of directors announces a dividend rate of ₹20 per share, you’ll receive ₹400 in dividends.
Some industries like insurance or regulated utilities are much likelier to pay dividends than other industries. Usually, older companies with a well-established cash flow prefer paying dividends while newer growth-based companies prefer reinvesting their earnings for further growth.
Also, note that any announcements of declaration of dividend income usually follow an increase or decrease in the stock price of the corporation.
What are the types of dividends?
There are mainly two types of dividends that a company can pay to its shareholders:- the special dividend and the preferred dividend. While the special dividend is paid to the ‘common share’ holders in situations of excess profits over several years, the preferred dividend is given to holders of ‘preferred share’ holders and are paid a fixed amount every quarter.
Also, there are plenty of ways to pay dividends to shareholders.
a) Cash:- Most companies still prefer to pay dividends using cash itself. They use their excess income for dividend payments and are either electronically wired or are provided in form of a cheque for extremely large amounts.
b) Assets:- Dividends can be provided in the form of physical assets, real estate, or other securities, although it is a rare practice for companies to be doing so.
c) Stocks:- Publicly listed companies can make and issue their own shares similar to how a central reserve bank can just print more money. Typically, each investor gets issued a certain amount of shares as dividends based on the number of shares he or she already owns in the company.
How to identify a dividend stock?
It is important to note that not all stocks are dividend stocks, i.e., not every stock listed in the stock exchange will offer dividends to its shareholders. Some stocks will be more valuable for their high rate of returns (known as growth stocks), while others will be preferred for their dividends. Typically, companies that are in growth or expansion stages will not issue dividends.
There are multiple ways to identify whether a company is a dividend stock or not. In this article, we will explore the use of screener.in
Step 1:- Log in or Register into screener.in
Step 2:- Search for the company on the top right search bar
Step 3:- Check for the ‘dividend yield’ field on the company financials. If the dividend yield shows 0.00%, it does not offer dividends. If the dividend yield shows anything over 0.00%, it does offer dividends, although the yield may vary.
How to compare dividend stocks?
Not all dividend stocks are equally good. There are a few factors that will differentiate whether a stock is better for dividends or not.
The factors to consider while choosing a good dividend stock are–
a) Dividend Payout Ratio:- The Dividend Payout Ratio is a percentage of the net earnings of the company that are offered as net earnings. This ratio is a useful indicator to gauge a company’s ability to send dividends among its shareholders for a long time.
You should prefer to choose a dividend stock with a dividend payout ratio of at least 50%.
b) Dividend Yield:- The dividend yield, defined as annual dividends per share/ dividends per share, indicates how much dividends a company tends to payout every year in comparison to its share price.
You should prefer to choose a dividend stock with a dividend yield between 3% to 6%.
c) Consistency:- The company needs to have shown consistency with regards to offering dividends and paying debt off over multiple years.
With these features in mind, you can use screener.in to search for those dividend stocks that match your criteria.
Step 1:- Log in or Register into screener.in
Step 2:- Click ‘Screens’ on the top toolbar. Once redirected to the screens page, click ‘Create New Screen’
Step 3:- In the search query, enter the following query
Dividend yield > 3 AND
Dividend yield < 6 AND
Dividend Payout Ratio > 50
Note that you can modify this query at your convenience if necessary.
Step 4:- Click ‘Run This Query’
Step 5:- You will now find a list of companies that match your query, along with their fundamentals. Sort them according to your criteria of choice and pick whichever dividend stock you prefer.
Disadvantages of Dividend Stocks
It is easy to be misguided by the comfortable passive income that dividends can provide an investor, but they must be cautious. Even though high dividend yields can be attractive, they could be at the expense of any growth potential of the company as well. It is not incorrect to say that every rupee that a company is paying back as dividends to shareholders is a rupee that the company chooses not to reinvest, grow and generate higher capital gains, which could be much more profitable to the investor.
Therefore, experts recommend avoiding evaluating a dividend stock based on its dividend yield alone. Companies may also have a very high dividend yield as a result of falling share prices. If revenues fall as well, it is very likely that this company will not be able to pay shareholders any dividend amount in the future.