‘Hard Work pays Dividends’ they say.
In non-market terms, dividend means being rewarded for the hard work put in.
Compare this with investing in the shares of a company. This holds true for Stock Market investing as well.
For a layman, a dividend is the reward that the shareholder gets for holding the shares of a company.
It is a reward that the Company can afford to give if it has performed well.
What exactly is a dividend?
Say, if a Company makes a profit of 1000 Rs, (just an example), what would it do?
a) It may decide to reinvest part of it back into business,
b) Repay its loans if required and
c.) Distribute a part of it to the shareholders.
Here part C explains the dividend.
How do I calculate dividend?
If the company announces a dividend of 100%, what does it mean?
It doesn’t mean 100% of the profit.
It means 100% of the Face value of that companies share.
Lets not get into the technicals of the Face value.Lets just understand the basics required.
So if Face value is Rs. 10, dividend will be 100% of 10 that’s Rs. 10 per share.
Face values can be Rs 1, Rs 2, Rs 5 or Rs 10 per share.
You can find out the face value of all companies in the moneycontrol website or any other well known site.
So don’t get carried away if dividends announced percentage is high. Check the Face value first and calculate the amount !
What is dividend yield then?
Now that you know what dividend is and how it can be calculated, lets understand dividend yield.
Lets take an example : Whenever you lend money to somebody, what do you ask him?
‘Mujhe kitna milega’ (meaning how much will I get) in return?
Its simple. How much money will I get if I invest in this company ?
So if I buy a share for Rs. 80, how will i benefit?
a) If the price goes up, i sell it off and make a profit
b) I hold it and and get a dividend from the company.
Let us suppose the company announces a dividend of Rs 10 per share, what is my dividend yield?
It goes like this
(dividend amount / purchase price) * 100
Its ( 10 / 80 ) * 100
that’s 12.5 %
So that’s how you calculate the dividend yield.
Once you know the dividend yield, all you do is compare it to a Bank FD yield or other deposit options.
Read also : Best investment plans for the middle class
Why should I invest in such companies?
Why should I invest in such companies if I’m getting a higher yield by buying and selling shares?
Any sports team with a strong attack also needs to have a strong defense. So when the attack fails, the defenders come in. Thus defenders are protecting or ‘hedging’ for the attackers.
In the same way, your portfolio needs to be protected with defensive stocks.
One part of your portfolio must definitely go into good dividend yield companies..
Because good times don’t always last.
In a bull market, whatever one buys goes up making even a first timer believe that he is an invincible expert in the Stock market.
In times of Bear markets which are sometimes long our portfolios can go for a toss and that can continue for a long time too. Sometimes years.
These stocks can be accumulated at lower prices to increase yields.
Making 15-20% in the short term is too good to resist compared to the small dividend amounts.
It is only when markets go sideways or downwards that one wishes he had put more money in safe stocks.
We are discussing long term here.
So How does one do dividend investing?
Keep booking profits when your targets are reached.
Keep this money aside and invest 50% of your profits (you could decide a different percentage) into good dividend paying companies.
( You could also consider investing this in the PPF or a recurring deposit ) The idea should be to separate this money from your major money making machine.
What happens as a result?
Amounts will be small initially but will build up over a period of time.
Additionally the dividends received can be re-invested in the same companies again to create the compounding effect.
This over a period of time will create wealth in the long term.
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Why invest in such companies when I can get higher returns by trading?
Many experts question this kind of investing saying that prices of these companies don’t increase much or even decrease eroding your capital. So what is the point of investing in such companies?
There are more ways of looking at this. Even when the share price of such companies fall, the dividend yield of such companies with fresh buying goes up.
And when their prices go up, you have the option to sell at a higher price increasing your profits.
That does not mean you blindly start buying stocks with high dividend yields immediately.
There are other factors to consider like past dividend paying record, business of the company and its future prospects.
There are many companies available with good dividend yields in the market. How will you choose such companies?
We will discuss more on choosing good dividend paying companies in my future posts.
A point to remember – Dividends build wealth slowly but surely. Please read my friend Hemant Thorat’s blog for some excellent insights.
Please comment or share your experiences with dividend investing.
A special Thanks to Digital Deepak for encouraging me to share my insights with you all