There are different types of investment stocks available in the stock market such as debt fund stocks, mid cap stocks, growth stocks and more.
Many investors invest in these stocks to get high returns with limited investments. However, there are other stocks too, that give investors regular payments against investment amounts. Such stocks are known as dividend-paying stocks.
Investing in dividend stocks is a great choice as it allows investors to meet their cash requirements as well as gives them a chance to see their stock value grow upward in the future.
Here, we will discuss everything about dividend-paying stocks and the rules you should follow while investing in them.
Before, getting started, let’s get acquainted with the term “Dividend”.
Dividends can be cash, reward or anything that a company gives to its shareholders against the shares they bought of a company.
Dividends can be issued in several forms such as cash payments, stocks or other forms.
Who declares dividends?
A company’s dividend is decided by its board of directors and it requires the shareholders’ approval as well.
A company does not need to declare its dividend. It is a part of a company's profit that the company distributes to its shareholders.
Smart Rules to Follow While Investing in Dividend Paying Stocks
Get a Detailed Insight into the company
Before investing in dividend stocks, it is important to do a stock market research and get detailed knowledge about a company and the sector in which it operates. This is because the potentiality of a dividend stock is highly dependent on the company’s fundamentals and the sector that it belongs to.
For instance, if the company operates in a volatile sector that is highly fluctuating in nature such as energy, it would affect the dividend price for sure.
Therefore, be careful before investing in these stocks. Also, don't forget to check the basic details of a company (stock value, past performance) and the risks associated with it.
Go For the Companies with Consistent Dividend Payments
Investing in the companies that give consistent dividend payout is always considered a better option. Consistent dividend payments is a sign of a strong company. This means, the company is constantly growing and has a strong background with long term stability.
Dividend incomes generated by these companies are consistent. Even if the dividend increases by a small number per year, they can give you incremented results due to compounding effects.
Be Aware from High Debt Companies
It is important to check the debt ratio of a company before opting for dividend stocks. If a company pays a good dividend payment despite having a high debt; then check the company details carefully.
They do so just to keep their stocks valuable. Hence, always check the debt market ratio of a company as the lower the ratio is; the more stable the company is or vice versa.
If the debt market ratio of a company hasn’t decreased with the time despite paying a high dividend, it would be ideal to not invest in such stocks as the debt impacts the value of the stocks which also affect the dividend payments in the future.
High Dividend Yield is Not a Sign of a Good Company
Many of you might think the stocks that offer a high dividend yield can be great stock. However, this is not so true. Sometimes, a high dividend yield is a way to mislead you.
Companies that pay a high dividend yield may be a sign of underperforming security and therefore it is of no use. Therefore, don't make decisions that completely depend on high dividend yield. While doing so, kindly check other factors too (debt market cap ratio, stock’s value, performance, future growth etc).
Pay Attention to Payout Ratio
The payout ratio tells the company’s ability to support dividend payouts. If the ratio exceeds 1 then the company pays more dividend to its shareholders than its earnings which makes it ambiguous about the company’s asset value and long term stability.
How to Identify Good Dividend Stocks?
The following steps can be used to identify the potential dividend stocks:
Step1: Check out the profit and loss of a company.
Step2: Check the earnings per share of a company i.e. whether it has grown in the 5 years or not.
Step3: Measure the growth of dividends per share in the last 5 years.
Step4: Compare if EPS growth and dividend per share growth are similar.
If EPS and Dividends per share growth are similar then the company is trustworthy, know why?
- Earnings per share mean the company's net profit is growing.
- Dividend per share growth means a company gives a consistent dividend to its shareholders.
- EPS growth similar to Dividend per share growth means as a company's profit will increase in its future, its dividend will also grow.
Difference Between Dividend Stocks and Fixed Deposits
Which is a better place to invest in; dividend yield stocks or Fixed Deposits? Many investors find FDs is the better place to invest while stock market lovers give preference to good dividend yield stocks than FDs.
Although both the instruments provide better returns to investors, the difference may depend on the investors.
Dividend stocks offer three benefits to the investors:
First: Although the starting yield on the dividend is slow compared to FD’s interest, it improves with time. Also, good dividend stocks provide stable yield income in the short term.
Second: Dividend stocks provide you with long term gain. Dividend per share will also improve yield on the dividend. Another advantage is: as the share price will also improve with time which provides a double profit for the investors.
If we talk about Fixed Deposits, then the interest rate is fixed. Also, it will never grow with time.
Conclusion
Dividend-paying stocks are the additional ones issued to the shareholders as a reward. Nevertheless, dividend-paying stocks provide consistent returns to their shareholders, one should not invest in such stocks without getting complete information about the company. Just because the company pays a high dividend doesn't necessarily mean it has good worth. Therefore, it would be ideal if you check the company’s annual report, earning growth, consistency of dividend payouts before investing in such stocks.
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