Why you should invest in dividends?

The question is whether dividend payout is enough of a reason to pick a particular investment option? Not really.

We invest seeking growth. Any productive asset will have some source of return other than a change in price. Dividends are part of the investment return that an equity investor receives.

The question is whether dividend payout is enough of a reason to pick a particular investment option? Not really.

High dividend yield stocks

These make for a tempting selection among listed stocks. Dividend yield measures your earning margin from dividends declared assuming you bought the stock today. For example, if the market price of a stock is Rs 100 and it announces a Rs 5 dividend per share, then the dividend yield is 5%. Some investors equate this with annual interest from deposits and see where the post-tax return is higher to decide which is a better investment option.

To put it in context, the dividend yield of the Nifty 50 index is around 1.3% currently. Some of the highest dividend yield companies are those semi owned by the Government or public sector companies. The dividend yield of many such companies is often in the range of 3%-5%, which as you can see is above the benchmark index dividend yield.

Dividend helps very long-term investors gain from recurring payouts to be used as income. However, investing in stocks only for the dividend is not wise. A company can continue to pay a high dividend from accumulated profits, making its dividend yield look good.

But at the same time, if incremental profits are not growing at the same rate, the market price of the share will suffer. Capital losses from price change can often outweigh dividend income in a year. Remaining invested in such stocks doesn’t make sense.

For example, public sector listed stock GAIL has a dividend yield of 7% or thereabouts which is attractive, but, the capital value or price has fallen 31% in the last year.

Dividend payout is not a sufficient factor to base stock selection on or even to decide the preferred asset class.

This is because, unlike the case of stocks where dividend payout is an additional income originating from the company to its shareholders, for mutual funds dividend payout is basically growth in capital value (including dividend received) being paid out as income. Which is like a withdrawal of your profit rather than an additional income coming to you. 

Mutual fund dividends are not relevant

Dividend taxation for equity mutual funds now makes the option unsuitable, however, even before this change in the last Union Budget, dividend options in mutual funds were not gainful.

This is because, unlike the case of stocks where dividend payout is an additional income originating from the company to its shareholders, for mutual funds dividend payout is basically growth in capital value (including dividend received) being paid out as income. Which is like a withdrawal of your profit rather than an additional income coming to you.

The best-case scenario is being invested in a good quality stock with an upward trending earnings growth trend, which also pays out high dividends and bonuses. Always rely on the quality of earnings and dividends will become remunerative over a long period along with the possibility of desired capital growth. In the case of mutual funds, it’s best to stay away from dividend plans and stick to growth plans where gains accumulate and compound.

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