Should a retail investor go for stocks with high dividends?

dividend stocks on india — Image Source : PIXABAY
Should a retail investor go for stocks with high dividends?

Who does not want to make easy money? But quick money comes with certain risks. There are several schemes available in the market today that promise a high return. But the share market is a place where one can make good returns than the conventional mode of investments in a short period. By investing in shares, you can make gains on capital and earn in the form of dividends as well. When invested wisely, your capital can multiple fourfold, but a small mistake could let you lose your funds. Therefore, it is considered one of the riskiest investments.

For a retail investor, it is necessary to take calculated risks to avoid any loses due to the fluctuations in the market. It is advised that patience is key to better saving and investing. There are multiple factors that a retail investor should consider before buying shares like the company's profitability, revenue, assets, liabilities, past performance, growth potential and more. One among them is the Dividend. Dividend is something that attracts investors. It is one of the most talked about investment themes amongst retail investors. Basically, it is the portion of the profit that companies distribute to their shareholders from time to time. Dividends are paid monthly, quarterly or annually and are decided by the Board of Directors of the company. It needs to be approved by the shareholders before the amount is paid.

Dividend considerations are important in any investment decision. But it should not be the sole driver. As an investor, you should consider returns in a long-term window. Underlying a stock's value appreciation potential is as critical as the dividend payout. The single most important factor that determines an early investor's success is the length of time they stay in the market, followed by the diversity of their portfolio because single stocks rarely make investor fortunes.

Many believe that dividend investing is a great way to create a steady flow of income. It can help investors enhance returns when markets are favourable. This also gives investors the ability to achieve positive results even when markets are unfavourable and hence reduces the risk in the portfolio considerably. Finding companies that pay dividends and are growing at a healthy rate can give you good capital appreciation as well going forward.

According to Arshad Fahoum, Chief Product Officer at Market Pulse Technologies, India's third largest stock market app, every investor should allocate a part of their equity portfolio to dividend generating stocks. He said that time and tax laws may change, but the fundamentals of investing don’t.

“Investors should look for dividend safety i.e. how likely is the company going to continue paying dividends at the same rate or higher in the future. One can look at the last 5-10 years of dividend paying history and for companies with stable income and cash flows," he said.

Plan retirement corpus with Dividends

Fundamentally, a good track record of dividend payments is a strong sign of reliability and a signal that stock will provide better returns in near future. It shows the sustainability of the company and confidence in future earnings growth. Investors can use the dividend to start funding for their retirement or long-term goals that they wish to accomplish. But does that mean a retail investor should allocate the majority of the portfolio to shares giving high dividends and don't opt for companies with no dividend?

Amit Narula, co-founder and director, Money In Minutes, said that investment with dividends has been fruitful in today's time. Retail investors can invest in high dividend yielding stocks provided they exceed the fixed deposit rate.

"Stocks offering good dividends will provide a stable flow return to the retail investor and when needed, they can decide to use them between meeting the expenses or to re-invest for compounding. If retailers want profit, then they need to understand the fact that best result will be cultivated if dividends will be locked for a certain period,” Narula said.

Some companies don't pay dividends, why?

Palka Chopra of Master Capital Services said that companies that don’t pay dividends on stocks are typically reinvesting the money into their expansion and overall growth of the company. This means, over time, their share prices are likely to appreciate in terms of value. Therefore, investors should decide after considering their financial goals and risk tolerance.

“Choose a company after analyzing its financial statements, look at its dividend payment history and check out its market reputation,” Chopra said.

Binod Modi, head strategy at Reliance Securities, explained that high dividend stocks are always a good option to invest in especially when market valuations appear to be stretched or expecting markets to correct as high dividend yields tend to provide a downside cushion for stocks. However, investors must focus on the business model of the company and sustainability of cash flow generation before opting for any high dividend yield stock.

"We have seen many PSUs despite distributing higher dividend and commanding healthy dividend yields have been ignored by investors for long and started attracting investors’ interest in recent months when market valuations started looking high," he said.

Don't invest blindly

Mohit Gang of investment advisory firm MoneyFront said that high dividend yield companies are usually mature companies that believe that paying cash dividends to their shareholders is a better use of their profits than investing it elsewhere. He suggested that an investor should not invest blindly in high dividend yield stocks and dividend yield should be looked at in conjunction with other ratios such as Return on Equity (ROE) and Return on Capital Employed (ROCE).

Suggesting an example, he said that Bharat Petroleum Corporation Limited (BPCL) has dividend yield of 4.43 per cent whereas Reliance Industries Limited (RIL) hardly pays any dividend. "But see the stock price movements over the past 5 years. Total Returns of BPCL 44% vs RIL 356%," he noted.

"Selecting a stock is an art where one has to give higher weightage on components such as management quality, product or service scalability, change management etc over the dividend which actually is a mere resultant of these factors," Sandeep Matta, Founder, TRADEIT Investment Advisor, said.