Dividend stocks: What are they and how do they work?
Investing in dividend stocks can provide the dual benefit of regular income and capital appreciation. Read on to know why companies pay dividends, how dividends can benefit you as an investor, and which dividend stocks to add to your portfolio.
Investors buy the stock of a company because they believe that the company is going to perform well and will help them grow their money over time. And when a company does do financially well, this tends to benefit the investors in two ways.
The first is through an increase in the company’s share price in the stock market, which enables investors to earn capital gains. The second is through dividends. When a company earns profits, it may decide to distribute them to its shareholders in the form of dividends.
How do dividends work?
It is the board of directors of a company that decides whether or not dividends should be paid out, as well as the rate at which dividends should be paid. The approval of a majority of shareholders is also typically required. Dividends are often paid quarterly or annually to eligible shareholders.
It should be noted that not all companies pay dividends, and profits don’t always guarantee dividend payments. Here are some key facts that should help you understand how dividends work:
- A company can decide to do several different things with its profits. It can distribute them among its shareholders, reinvest them in the business, use them to buy back its stock, or simply keep them as a reserve to draw upon during rough times.
- High-growth companies tend to reinvest profits for growth and expansion plans instead of prioritising dividend payments. Hence, so-called “growth stocks” rarely pay dividends.
- Companies that are already well-established with stable profits and cash flow tend to pay regular dividends.
- Some companies may pay dividends even when they have not made enough profits, in order to maintain their reputation of being a dividend-paying stock.
- Industries that are known to have dividend-paying stocks include utilities, financials, healthcare, energy, and consumer staples.
- The dividend per share is expressed through a financial ratio called the dividend yield. It is the percentage of a company’s share price that it pays as dividends each year.
But why do companies pay dividends in the first place? Let’s take a look.
Why do companies pay dividends?
Dividends reflect positively on the company’s financial health and increase investor confidence. Not only does announcing a dividend show that the company is earning enough profits to cover its operating expenses, but also that it cares about its investors and wants to reward them for investing their money. In the short term, announcing a dividend payout can also have a positive impact on the stock price and drive it up.
While dividend payouts are usually seen as an indication of financial health and stability, sometimes it could also mean a lack of future growth prospects, since the company may not be reinvesting profits for new projects that could earn higher returns.
List of dividend stocks
There are certain companies in every market that are known to consistently distribute their profits to investors through dividends, and dividend yields of 2% to 6% are generally considered decent dividend yields.
Here’s a list of some of the best Indian dividend-paying stocks with high yields:
|Indian Oil Corporation Ltd.||10.76%|
|Indus Towers Ltd.||7.72%|
|Bharat Petroleum Corp. Ltd.||4.65%|
Here’s a list of some of the best US dividend-paying stocks with high yields:
|Devon Energy Corp.||10.00%|
|Lincoln National Corp.||8.01%|
|Verizon Communications Inc.||6.71%|
* Annual dividend yield as of March 31, 2023.
Remember that the dividend yield alone should not be a deciding factor when buying dividend stocks. You should also look at the other financial fundamentals of a company and consider if it would make a good addition to your existing portfolio. You also need to consider your financial goals, risk appetite, and investment horizon before investing in any stocks.
Moreover, you shouldn’t hesitate to look beyond the Indian market: to make investing easier for you, the best apps for the share market today provide access to high-performing US dividend stocks across industries. Thus, you can now add the best dividend stocks in the world to your portfolio with just a few clicks! In addition, such apps can also provide AI-based investment recommendations, which you can use to build a portfolio that’s the most strategically suitable for you.
Should you invest in dividend stocks?
Yes, there are several benefits of adding dividend stocks to your portfolio. One of the biggest benefits is a regular stream of income. Dividend stocks provide passive income while also allowing you to benefit from possible capital gains in the future.
When you buy a dividend stock and hold it for the long term, you can earn dividends quarterly or annually every year for the entirety of your investment horizon. And when you finally decide to sell the stock years later when the market price is hopefully significantly higher than when you had bought it, you earn capital gains. This dual benefit of regular returns and capital appreciation is one of the main reasons why investors buy dividend stocks.
Another benefit is that dividend stocks tend to be more stable and less volatile than non-dividend stocks. That’s because it’s usually only large, financially stable companies that pay dividends to shareholders.
Dividend stocks can thus be a valuable addition to any investing portfolio, providing investors with a consistent stream of income as well as long-term growth potential. However, before investing, you must carefully research each dividend stock to ensure that it corresponds with your financial goals and risk tolerance. You should make informed investing decisions by evaluating aspects such as the company’s financial health, dividend history, and payout ratio.
Remember to diversify your portfolio and keep up with the latest news on market trends and economic factors that may have an impact on your assets. Dividend stocks can be a strong instrument for generating wealth and attaining financial goals if approached carefully and with a long-term mentality.
Yogesh Kansal – Bio
Yogesh is a Co-Founder at Appreciate, a fintech platform helping Indians achieve their financial goals through globally diversified one-click investing.
Yogesh Kansal – Image