A company when earns profits has three options available to it. One, it can declare part of the profits to its investors in the form of dividends. However, in this case, the company has to decide on the dividend payout ratio. Second, it can hold all the amount of profit and invest in back in the business so as to get more customers, more sales and more profits. In this case, though delayed but a part of the benefit will again be passed to the investors. And third, a company can use the amount of profits to buy back its shares. This will reduce the number of shares in the market and the earnings per share for the remaining shares will be enhanced. This will have twin benefits for the shareholders – one, they may receive a high dividend from the next year onwards and two, the chances of increase in the market value of the shares will be bright. The right choice from these options ultimately depends on the management of the company. A solution that suits one company may or may not seem to be a working solution for the other company. Therefore, each company has to make their choice on the basis of their conditions and investors confidence in the company. Now, when it comes to taking a decision on the stock to be invested, then first of all, you need to first understand as to how the dividend works.
Why people want to invest in dividend paying stocks?
Even if the share prices of some companies do not move heavily on the upper side, but still these companies may pay a hefty amount as dividend. Such kind of stocks is usually the choice of those investors who are more interested in getting dividend. Usually this kind of condition prevails in the large sized companies who are established. And their investors usually hold stocks for long period of time because rather than capital appreciation they are happy with the current yield.
How does the dividend yield create a difference?
In a stock market, you will find high priced shares, shares of blue chip companies and you will also find penny stocks. Now let us understand the differences in the dividend yields of these companies. Let us say, that a company has the share costing Rs. 100 and declares Re. 1 per share as the dividend. In this case, the dividend yield is 1%. Let us take another company whose share costs Rs. 10 and it also declares Re. 1 per share as dividend to the shareholder. In this case, the dividend yield is 10%. Confused? I understand that in the second case, with less of investment, an investor will be able to get the same amount of dividend as offered in the first case. But don’t get lured by the second case. The reason why I m stopping you to get influenced by the second stock category is – it is a penny stock. The penny stocks rarely pay dividends and even if they do so, you won’t get capital appreciation on that stock. So, when you compare the overall returns (current yield + capital yield) of these stocks with the high priced stocks, you will find a low rate coming out of them. After all, there is no shortcut in the stock market that can let you earn a huge amount from smallest of your investments. Therefore, what looks fairer on the face, may appear to be darker if you dig for the deep down information.
Are investments in a dividend stocks a good option?
If you are looking for a regular income and you are able to find a reliable company to invest in, then of course, investment in dividend stock is a good option. However, if you want to speculate in the market and want to earn a quick return without holding the stock for long, then dividend stocks is surely not your cup of tea. But in case you prefer to invest in dividend stocks then do remember that payment of dividends are not guaranteed. If the company does not earn profits in a specific year, then it will not be bound to pay you the dividends. Let us take a different case, a company despite earning profits has not declared dividend for the current year. In this case also, you cannot force the company to pay dividend as what to do with the profits is entirely the decision of the management.
Therefore, while investing in a dividend stocks, you should do a back ground study on the dividend paying trend of the company. Then only you should put your investments in it. Therefore, the key is to weigh your choices and options and take decision accordingly.