Which is Better for You: Dividend Investing or Value Investing?
Dividend investing is lucrative to a lot of people in India. You have even heard of many examples where people get huge dividends every quarter or year. The news impressed everyone: “SBI paid approximately ₹5,788 crore as a dividend to the Indian government for the financial year 2022-2023.” So before investing in dividends or how you can get dividends from companies, let’s first understand the dividend.
What is Dividend?
In simpler terms, if you buy a share of the company, you will be the part owner of the company, and you will receive your share of the profit if the company decides to distribute the profit among the shareholders.
For example, if a company declares a ₹10 dividend per share and you own 100 shares, you would get ₹1000.
A dividend is a portion of a company’s profits that is paid out to its shareholders. Think of it as a reward for owning shares in the company. If you own stock in a company that pays dividends, you’ll receive a regular payment, usually in cash or additional shares, based on the number of shares you own.
But why do some stocks pay the dividend while others don’t?
So there are two types of stocks:
- Growth stocks
- Dividend stocks
Growth stocks try to make their value go up over time. Dividend stocks, on the other hand, pay out regular dividends, making them a stable source of income.
We will understand later in the blog about growth stocks vs. dividend stocks.
How you can earn dividends from shares.
First, you need to identify all the companies paying dividends to their shareholders. You can buy the shares of those companies from the broker or the online platforms.
Once you own shares, you are eligible to receive dividends. Companies usually pay dividends on a regular schedule—quarterly, semi-annually, or annually. The amount you receive depends on the number of shares you own and the dividend declared by the company.
How you will get the dividend payment:
The dividend is paid directly to your bank account or brokerage account, depending on the broker or the online platform you choose. For example, if a company declares a₹10 dividend per share and you own 100 shares, you will receive ₹1000 in dividends.
After receiving the dividends, you can choose to reinvest your dividends by buying more shares in the company, which can help your investment grow. Alternatively, you can use the dividend payments as income. And you can use it for your daily expenses.
Taking the dividend as income will not reduce the value or the number of shares you have.
Keep in mind that dividend income is taxable in India. It’s important to report your dividend income in your tax returns and pay any applicable taxes. the dividend income is the taxable income, and taxes are at the slab rates applicable for FY 2023-24 (AY 2024-25).
Suppose you invest ₹1,50,000 in Redington, one of India’s leading distributors of IT and mobility products, known for its consistent dividend payouts. If Redington’s share price is ₹150 and it pays an annual dividend of ₹16 per share (a 4% dividend yield), you would be able to buy 1000 shares. Over the course of the year, you would receive ₹16000 as dividend income.
Number of Shares Owned: The total number of shares you hold in the company.
Dividend per Share: The amount of dividend the company pays for each share.
Dividend = Number of Shares Owned×Dividend per Share
(1000 x 16)
Total Dividend: ₹16,000
Dividend Yield: 4% (₹16 dividend per share ÷ ₹150 stock price × 100)
The dividend yield tells you that you earn 4% of the stock’s price as income.
If you choose to reinvest these dividends by purchasing more shares, your investment will grow over time. If Redington increases its dividend payout annually, your income will also grow, helping to offset the impact of inflation.
Pros and Cons of Dividend Investing.
PROs-
Regular Income Stream:
Dividends provide a steady source of income, making them attractive to retirees or those seeking passive income without having to sell their shares.
Lower Risk:
Companies that pay regular dividends are often more stable and financially sound, which can reduce investment risk. Dividend-paying stocks tend to be less volatile than non-dividend stocks.
Compounding Growth:
Reinvesting dividends can accelerate the growth of your investment through the power of compounding. Over time, this can significantly increase your wealth.
Inflation Hedge:
Companies that increase their dividends regularly can help protect your purchasing power against inflation, as your income from dividends grows over time.
Tax Benefits:
In India, dividends are taxed at the individual’s income tax rate, but they can still be more tax-efficient compared to other forms of income, depending on your tax bracket.
Long-Term Focus:
Dividend investing encourages a long-term investment approach, as it focuses on steady income rather than short-term market gains.
Cons-
Lower Growth Potential:
Dividend-paying companies often reinvest less of their profits back into the business, which can limit their growth potential compared to non-dividend-paying companies.
Dividend Cuts:
Dividends are not guaranteed. Companies may reduce or eliminate dividends during tough economic times or if they face financial difficulties, which can reduce your income.
Tax Implications:
In India, dividends are taxed as income, which can reduce your net return, especially if you fall into a higher tax bracket.
Limited Diversification:
Focusing too much on dividend-paying stocks may limit diversification, as you might miss out on high-growth companies that do not pay dividends.
Interest Rate Risk:
Rising interest rates can make dividend stocks less attractive compared to fixed-income investments like bonds, which could lead to a decline in stock prices.
Inflation Risk:
If a company does not increase its dividend over time, your income might not keep pace with inflation, reducing your purchasing power.
Dividend investing vs. value investing
Dividend investing focuses on earning regular income from stocks that pay constant dividends, which appeals to investors looking for stable, low-risk returns. Value investing, on the other hand, is selecting and purchasing inexpensive stocks with excellent fundamentals to capitalise on long-term capital appreciation as the market corrects its pricing. While dividend investing prioritises income security, value investing seeks to maximise growth by capitalising on market inefficiencies.
Why choose dividend investing?
- Income Generation: Dividend stocks provide a regular income stream, which is especially valuable for retirees or those looking for a steady income source without selling their investments. And it can also be your secondary income or it can be helpful in paying EMIs.
- Reinvestment Opportunities: Dividends can be reinvested to buy more shares in the same company, which can help you benefit from compounding over time. And you have the option to invest or spend your dividend. If you want to keep the value of investing, you can reinvest the dividend, which will increase your share and value your portfolio.
- Stability and Predictability: Indian companies that consistently pay dividends, mostly Blue companies or PSU companies, and companies, like SBI, pay a fair dividend value against their share price. And these companies tend to be more stable and financially sound.
- Inflation Hedge: Dividend growth stocks in India, which increase their payouts over time, can also help you protect against inflation.
- Tax Benefits: Under the current Indian tax regime, dividends are taxable at the individual’s applicable income tax slab rates, but they are still a tax-efficient way to earn money compared to other forms of income. As in your tax slab, you can somehow manage to adjust the taxes by following proper investing.
How to Choose Dividend-Paying Stocks in India
Now coming to the most important part, how should we pick the stock that pays us the consistent dividend payout as well as the decent value appreciation of the stock.
Always follow this pointers before picking any stock for the dividend payouts.
Dividend Yield
The dividend yield is the ratio of a company’s annual dividend to its share price, expressed as a percentage. It gives you an idea of how much income you can expect from your investment.
If a company in India has a share price of ₹1000 and pays an annual dividend of ₹25, the dividend yield is 2.5% (₹25/₹1000).
While a high dividend yield might seem attractive, it’s crucial to consider whether the company can sustain its dividend payments. Sometimes, a high yield could indicate that the company is under financial stress or that its stock price has dropped sharply.
An ideal dividend yield can range from 2% to 6%.
Dividend Payout Ratio
The dividend payout ratio is the percentage of a company’s earnings paid out as dividends. It is calculated by dividing the annual dividends per share by the earnings per share (EPS).
If an Indian company earns ₹100 per share and pays out ₹50 as a dividend, the payout ratio is 50%.
A lower payout ratio suggests that the company is retaining more of its earnings for growth, while a higher ratio might indicate that the company is focused on returning cash to shareholders. However, an excessively high payout ratio could be a warning sign that the company might struggle to maintain its dividend in the future. It can be important ratio as it will show the company’s future goals.
An ideal dividend payout ratio can range from 35% to 50%. So if the company is earning ₹100 and paying between ₹35 to ₹50. Then it can be considered as good.
Dividend Growth
Look for Indian companies with a history of increasing their dividends over time. Dividend growth is a sign of a company’s financial health and its commitment to returning value to shareholders.
An Indian company like Infosys, which has consistently increased its dividend payouts over the years, indicates strong financial performance and a shareholder-friendly policy.
8% per year can be considered as good growth.
Company Stability and Financial Health
Invest in companies with strong balance sheets, consistent earnings, and a competitive advantage in their industry. These companies are more likely to maintain or increase their dividend payments, even during economic downturns.
Blue-chip companies like HDFC Bank or Reliance Industries have a long history of paying dividends and are considered financially stable.
Industry and Sector Considerations
Different industries in India have varying dividend payout practices. For instance, companies in the utility and consumer staples sectors often have higher dividend yields, while tech companies might reinvest more profits into growth rather than paying dividends.
Power Grid Corporation of India, a utility company, might offer a higher dividend yield compared to a tech company like TCS.
Diversifying your dividend stocks across different industries can help mitigate risk.
Total Return
While dividends are important, don’t overlook the total return of the stock, which includes both the dividend payments and the capital appreciation. A company with a lower yield but strong growth potential might offer a better overall return compared to a high-yield stock with limited growth.
A company like Asian Paints, which offers moderate dividends but strong price appreciation, might provide a better total return than a high-yielding, slower-growing company.
Conclusion
Dividend investing is a smart way to earn steady income, but it works differently for everyone. Young people should reinvest the dividends for the value creation till the time they are about to retire or they need break in career but like retirees or long-term investors they can consider dividends as their regular income. By picking companies with a solid history of paying dividends, strong finances, and growth potential, they can enjoy regular income while growing your investment.
Just make sure to consider both the dividends and the stock’s potential for growth. With the right approach, dividend investing can help build wealth and create a reliable income stream.
Dividend Investing and extra source of income is great but we should also look at the aspect of valuing stock. It is very important to look at the vision of the company while selecting the dividend stocks.