Thursday, January 14, 2010

Investment-Divident Income

What is dividend income?

Dividend is the portion of profits that a company distributes among its shareholders in the form of cash. Usually it is expressed per share. In some cases it is expressed as a percentage of the share’s face value. So if your company declares a 100% dividend, you will get an amount equal to the face value of the share and not equal to its market price. When dividend is expressed in percentage terms, it is the face value that is referred to. The same holds good when it comes to dividends declared by mutual funds — it is the par value of units that is considered.

What is dividend yield?

The ratio of dividend amount per share to the prevailing market price of the share is a yardstick to identify attractively-valued stocks. Other things remaining equal, the higher the dividend yield, more attractive is the stock for investors. Some draw a parallel between dividend yield and the rate of interest quoted on a fixed deposit, the only difference being that on the latter, the amount invested is expected to be returned along with a pre-determined interest whereas in the case of stocks, neither future dividends nor prices are fixed. One can extend the logic of dividend yield of a stock to a stock index to determine if an index is quoting at a cheap valuation.

Are stocks with high dividend yield good investments?

If you come across a stock with a high dividend yield, don’t lap it up blindly. Check if the dividends are regularly paid by the company, which should have a dividend policy in place. You should also be aware of the source of the dividend, i.e., whether it is paid out of a previous year’s profits or out of profits earned from non-operating activities such as sale of assets, etc. You further need to have a good sector understanding to pick up good opportunities. Investing on the basis of dividend yield has emerged as a popular practice in developed markets. One such popular investing practice is ‘Dogs of Dow’ where investors each year pick up 10 stocks which have the highest dividend yields on the Dow Jones Industrial Average index. These stocks are held till the end of the year. This has made many invest in equities with minimum efforts on research and earn healthy returns.

How will I benefit from dividend income?

In India, equity dividends paid by listed companies are tax free in the hands of shareholders. The company declaring the dividend has to pay a dividend distribution tax to the government. Though dividend is one of the reasons that makes investors hold on to equities, capital appreciation is a more important reason. Dividend yield can be a good tool to identify an undervalued stock that may offer good appreciation. There are investors who recognise the importance of dividend yield investing.

Mutual funds have long ago identified it as a useful strategy in the Indian capital markets. There also are dedicated schemes that invest in equity and equity related instruments of companies focusing on dividend yields of companies. The schemes maintain a portfolio of stocks that are available at attractive dividend yields among a host of other factors. The strategy is known as a defensive investment strategy.

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