Dividend Yield Stocks - A Guide to Dividend Investing | Espresso

What You Should Know About Dividend Yield Stocks?

If you want to invest in the stock market but desire a regular income stream, one of the best ways to do so is by investing your money in dividend yield stocks. Investing in the best dividend stocks can help you create wealth and receive a stable income.

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These stocks help the investors make profits in two distinct ways – through stock price appreciation and regular payouts made by the company in dividend payments. Dividends are a part of the company income paid out to the shareholders.

Some renowned companies distribute dividends to their shareholders annually to establish goodwill and maintain shareholder trust. Therefore, dividend yield stocks are a smart investment for investors who want high returns at medium risk.

Here is everything you should know about dividend yield stocks.

What is Dividend Yield?

Companies retain a part of their profits for reinvestment in the business and distribute the rest as dividends to their shareholders. The dividend yield is a financial ratio that indicates the amount of cash dividends paid to the shareholders relative to each share’s market value. The dividend yield is obtained by dividing the dividend paid by the market price per share and multiplying the resultant figure with 100.

For instance, Company A, with a share price of ₹100, pays ₹10 as dividend per share. In this case, the dividend yield is 10%.

A high dividend yield means the company is paying a large share of its profits to its shareholders as dividends. Alternatively, a low dividend yield means the company is paying a low dividend to its shareholders. You can compare the company dividend yield with the industry average to know if the dividend payout is high or low
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How Do Dividend Stocks Work?

The Board Of Directors determines the dividend distribution based on the company’s earnings. It is provided on a pro-rata basis wherein every investor receives the dividend based on the number of shares they have in the company.

There are four important dates in this regard.

  1. Dividend declaration date - The Company announces the dividend.
  2. Ex-Dividend Date - The date on or after which the new buyer of the stock will not receive the previously declared dividend.
  3. Record date - Deadline to be listed as a shareholder in the company’s books.
  4. Payment Date - Dividend is paid to shareholders.

Let us consider a dividend stock example. Suppose that the stock’s face value is ₹8, and the company declares a 10% dividend. As a result, every shareholder will receive Rs. 0.8 per share. Therefore, if you own 1000 shares in the company, you will receive ₹800.

Why Invest in Dividend Yield Stocks?

When you invest in dividend yield stocks, it can be termed a smart long-term strategy. Dividend yield stocks are a good investment during market volatility because they pay off high dividends. These are suitable for investors with a low-risk appetite who want a regular income stream by investing in stocks.

High dividend stocks also indicate that the company is not reinvesting the entire money and is sharing profits with its investors, thus benefiting them. Further, dividend yield stocks also enjoy favourable tax treatment. Investment in high dividend yield stocks becomes an efficient tax-saving asset.

However, before investing in dividend yield stocks, check the company valuation and the past dividend records. Few public sector banks, public companies and foreign multinationals in the consumer and pharmaceutical sector in India offer high dividends to investors and can be a wise investment option.
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What are the Tax Benefits of Dividend Yield Stocks?

The dividend payout received by the investor is tax-free, implying you do not owe any tax on the dividend sum you receive. Some investors also use the concept of dividend stripping to get more tax benefits.

Dividend stripping is the practice where the investors buy a share for a short period only before the declaration of the dividend and then sell the share after the dividend is distributed.

So, the share price is ₹20 before the dividend declaration of ₹5. Post the dividend payment, the share price is ₹15. In this case, the investor buys the share worth ₹20 before the dividend declaration and sells the share after the dividend is received and when the share price falls to ₹15. This practice of dividend stripping results in twofold tax benefits.

First, the investor gets tax-free dividend income. Second, since the share was sold at a loss (sale price is less than the purchase price), the investor registers a capital loss, adjustable against any other capital gain. This means dividend stripping results in tax-free income and reduces your taxable income for the financial year.

To Sum it Up

Overall, adding dividend yield stocks to your portfolio can be beneficial if you are a risk-averse investor and want a stable income. Dividend yield stocks can reduce volatility and improve your total returns, enabling you to achieve your financial goals quickly. However, it is critical to select the right dividend yield stocks to avoid falling into a dividend trap.

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Frequently Asked Questions

The number of dividend yield stocks you should own depends on your portfolio size and risk tolerance.

Ideally, a dividend yield of 3% is considered good from the investment perspective. However, solely looking at the dividend payout is not sufficient to make an investment decision.

Dividend-paying stocks benefit investors in multiple ways. These stocks pay out regular dividends, and the price appreciation in the stock price is also beneficial for the investors. Further, dividends received are tax-free and further, the strategy of dividend stripping increases the tax benefits even further for dividend stock investments.