Stock prices have been on a see-saw for months now, increasing the risk for investors to rely on capital gains. But capital gains aren’t the only way to earn from stocks; dividends too add to the overall earnings from stocks. Dividends reflect a company’s financial strength.
What are dividends?
Dividends are basically that part of a company’s earnings or profits which are paid out to shareholders. Although, they aren’t guaranteed, they do provide a more regular and stable income stream as compared with capital gains. Typically, dividend payments are made annually, but there is no hard and fast rule. They could be paid out semi-annually or once in two years or at any frequency the company chooses. There are two modes of paying dividends, through cash or via additional stock in the form of bonus shares. Dividend payouts are more frequent with companies that have significant cash balances. Mostly, this could be a characteristic of a particular type of business. For instance, the consumer goods companies, services companies and government-owned undertakings.
What is dividend yield?
Dividend yield is essentially a financial ratio that shows how much a company pays out as annual dividend with respect to the market price of its share. If there is no capital gain from owning a stock, then the dividend yield is the only return from holding a particular stock. Comparing the dividend yield of two companies would help you assess whether your stock is paying you a better dividend than another. Comparing the absolute quantum of dividend paid may not always give the best picture because you also pay a price (market price) to own a stock.
What are dividend yield funds?
A few mutual fund (MF) schemes are structured around this concept. A look at the past one-year returns, according to data provided by MF tracker Value Research, shows that all but one of these schemes have outperformed the average returns of their category.
What to do?
Investors who want regular income can look at stocks, which pay regular dividends and have a relatively high dividend yield. For example, Infosys Ltd has been declaring an interim (mid-year) and final (year-end) dividend every year for the last 15 years. It has also announced bonus issue of shares five times since 1994. These earnings are in addition to any capital gains. Similarly, Hindustan Unilever Ltd has paid at least an interim and a final dividend every year since 1997.
However, there is no guarantee as such. While past payouts do not signify payments in the future, you can use the track record as a benchmark to assess dividend action going forward.