Investing in dividend yield stocks is one of the ways of creating wealth and receiving a steady stream of income. Dividend-paying stocks allow investors to profit in two ways: stock price appreciation and payouts made by the company. Dividends are basically a portion of the income that a company distributes among its shareholders.
Some established companies have the practice of disbursing the majority of their annual profits annually among investors in order to establish goodwill in the market.
A company’s dividend policy is often seen as a testament to its confidence in future earnings growth and sustainability of the business. In another words, a good track record of dividend payments is a strong sign of reliability and an indication that the stock would give good returns in future.
Such companies already tend to have strong market presence, which justifies the risk factor to some extent. Holding stakes in the companies that distribute regular dividends can lead to higher yields in the future. Investors can use dividends that they receive to buy more stocks and reap the benefits of dividend reinvestment.
Dividend yield stocks are generally less risky than non-dividend ones. Yet, it’s important to avoid judging a company based on dividend payment alone. When looking at high dividend yield stocks, one should also avoid the temptation of seeking out names with the highest yields.
Remember, paying dividend is not an obligation, and a company may decide to cut the same any time in the future. It means, thereby, that it is up to the company to decide whether it wants to pay dividend to shareholders or avoid such payments at any point of time for any reason.
Moreover, if tax rates on dividend earnings rise, it may become a less attractive option for a company to pay out. Also, any cut in regular dividend always tends to undermine investor confidence, causing stock prices to fall sharply. That may make it double trouble for dividend stock investors.
One of the best strategies to make money in stocks is to use the old philosophy of ‘buy and hold’, which is best suited for long-term investors. One should understand that any investment needs to be kept locked in for a certain period in order for it to be able to deliver profits.
In dividend yield stocks, an investor enjoys the benefit of dividend income along with capital appreciation. But before picking such stocks in the hope of dividend earning, one should make it a point to go through the financial statement of the company, look at its dividend payment history and check out its market reputation.
(DK Aggarwal is the Chairman and MD of SMC Investments and Advisors)