What Are Dividends? - Types & Advantages of Divident Stocks | Espresso

Know Everything About Dividend Stocks

The share market is a massive financial arena wherein you buy and sell securities to earn a profit. So naturally, as an investor, you will look forward to appreciating the share value in the short term or long term. 

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However, that is not the only way to make a profit! There are dividend stocks that yield a good and easy way to reap a consistent source of income. So, if you are planning to invest in dividend stocks, here is a detail to help you out.

What is a Dividend?

A dividend refers to the distribution of profits to the eligible shareholders of a company. It is determined by the Board of Directors of the Company.

What are Dividend Stocks?

Stocks of companies that consistently distribute their profits as dividends to their shareholders are dividend stocks. Therefore, it is a way of paying shareholders their return on investment.

The companies offering dividend stocks have a strong financial record and a solid presence in their respective industry.

What are the Types of Dividend Stocks?

There are two types of dividend stocks based on the nature of return on investment.

1. Dividend growth stocks - Stocks of companies with higher potential to increase the future dividend rates.

2. High dividend stocks - Stocks of companies with less probability of increasing the future dividend rate as they have been providing a higher dividend rate to their shareholders.

The companies set aside a portion of the profits to distribute dividends to the shareholders and the remaining portion for re-investments.

What is Dividend Payout Ratio, and How is it Different from the Dividend Yield?

The dividend pay-out ratio refers to the portion of the company's net profit provided as dividends to the shareholders. And the dividend yield measures the earnings per share for the investment from the total dividends declared to the investors. It is calculated by dividing the dividend by the share price and multiplying the result by 100. For instance, if a company's share price is ₹100 that offers a dividend of ₹1 per share, the dividend yield is 1%.

What are the Advantages of Investing in Dividend Stocks?

Having seen the important terms regarding dividend stocks, let us understand its advantages.

1. Good source of passive income - As the companies offer a periodical and consistent source of income to the shareholders, it is a good source of regular passive income.

2. Helps in diversifying your portfolio - Dividend stocks are extremely low in risk. The stocks do not lose their value even after an extreme economic downturn. If there is a decline in the price, they gain it back, making it a reliable option to invest and protect the capital.

3. Option to reinvest - As an investor, you have the option to utilise the dividend payout as a cash benefit or reinvest in the same stock. You benefit from dividend compounding that can boost your steady returns by reinvesting.

4. Increased protection against inflation - Considering the increasing inflation rate, you can get effective returns based on the growing dividend yield.

5. Simply 'buy and hold' - As a busy professional, you may not have the time to keep tracking your investment and the price movement. Dividend stocks are less susceptible to market volatility. Therefore, you can just buy the stocks and hold them long-term.

Why Do Some People Hesitate to Purchase Dividend Stocks?

Some investors don't prefer investing in dividend stocks for a few reasons.

  1. Dividend stocks that provide regular income are generally low-growth stocks. Therefore, the price-to-earnings ratio (P/E ratio) is less.
  2. A company providing dividend stocks may not have increasing investment opportunities in its business.
  3. Companies offering dividends might decrease in value. Some investors see paying dividends as a partial liquidation of their business. Companies that utilise their profits for investment or reserve them for future purposes tend to keep growing to increase their competency. If the company keeps paying dividends, it can deteriorate its value among the competitors in the industry.

Who Should Invest in Dividend Stocks?

Dividend stocks are less risky compared to other growth stocks. Therefore, people who have a conservative risk profile looking for a regular source of passive income can look forward to investing in dividend stocks. However, based on the requirements, it is important to study the industry, research the different companies providing dividends, understand their business, and invest for better-assured dividend returns. In addition, people nearing retirement can park their reserves in such well-established companies to earn an income to suffice for their everyday financial needs.

Conclusion

Dividend stocks are companies that distribute the profit earned to the investors regularly. There are the dividend growth and the high dividend stocks. Dividends from well-established and reliable companies provide dividends regularly. Also, it is less risky to invest in dividend stocks as they do not get affected much due to any market volatility. However, companies providing dividend stocks are seen as low in growth due to limited sources of business expansion. Therefore, it can be valued less in comparison to the different businesses. So, if you are looking for a regular return on investment with a low-risk profile, then dividend stocks can be ideal!

Share Market Knowledge Centre

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Frequently Asked Questions

Dividend stocks of renowned companies having steady financials and business growth opportunities provide an appreciation of share price while also offering regular dividends to the investors.

The requirement of dividends is based on the investor's approach. If you are looking forward to making consistent returns in the long term, then dividends are good. On the other hand, if you are looking for fast growth of your wealth, investing in dividend stocks may not be wise.

If you have decided to purchase dividend shares, consider buying the dividend stocks of companies with a dividend pay-out ratio of at least 40% and an overall dividend yield above 3%.