Consistent dividend paying companies are better candidates for using yield as a parameter before investing
The returns on equity investments have two components – the price return and the dividend earned. Dividends are cash payments to the shareholder. Usually, companies with healthy cashflows tend to declare dividends. But though dividends may seem attractive, to get a better picture, it is important to ascertain the dividend yield of a stock.
Dividend yield is calculated by dividing the cash payout with the price of the share. For example, if a company announces Rs 3 per share as dividend, and the current market price of the stock is Rs 100, the yield is 3 per cent.
In markets that remain unchanged for prolonged periods, dividend yield can give that leg up to returns. It also helps investors ascertain the relative attractiveness of a stock. Dividend yield can also be computed for indices. The dividend yield for the Nifty 50 was 1.25 per cent on January 20, 2020.
Is it a suitable parameter?
Consistent dividend paying companies are better candidates for using yield as a parameter before investing.
You should exclude one-time dividends paid out. These can be due to disbursal of profits from sale of assets or for certain special occasions (silver or golden jubilee celebrations). Such disbursals are clearly specified as special dividends.
Dividend yield can also look attractive in stocks that keep falling or where markets fail to accord them better valuation multiples. Stocks prices can be depressed due to poor financial outlook, industry headwinds, economic cyclicality, and even corporate governance issues. So, while the dividend yield may be healthy, you could actually face capital erosion!
Investing in dividend yield stocks
Building portfolios of dividend yield stocks has been a forte of value investors across the world. In India, public sector undertakings and multi-national companies are seen as regular dividend paying entities among others. Experts say that you should not ignore future business growth prospects while building a portfolio on the basis of dividend yield.
Nifty Dividend Opportunity 50 TRI tracks a basket of 50 dividend paying stocks. It has delivered 10.5 per cent returns annually over the last 10 years. The Nifty 50 TRI, over the same period, delivered 10.2 per cent.For retail investors, there are options available in mutual fund schemes. Dividend yield funds have been around for the past 15 years now. According to data from Valueresearch, dividend yield funds as a category have delivered an average 9.8 per cent returns annually over the past 10 years.