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Why to Buy Dividend Stocks? Research Team | Posted On Thursday, December 26,2019, 12:48 PM

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Why to Buy Dividend Stocks?



What are Dividend Stocks?

To begin with, let’s understand the term dividend stocks. All of us have come across these words at one time or the other from several news platforms. Dividend stocks are nothing but a periodic (quarterly, annually or semi-annually) payment made by an organization to its shareholders. It is usually a division of profit. The amount is decided by the Board of Directors and has to be approved by the shareholders. The dividend can be paid either in the form of cash or stock.

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Why Buy Dividend Stocks?

  • Passive income:  Earnings from the stock market can be highly fluctuating. The earnings usually depend on the stock value that goes up or down the market, based on various factors. However, dividend stocks pay an amount to its shareholders when the market value is stagnant or fluctuating. So it is a source of passive income.
  • Stability: Dividends can be paid only when a company has a stable stream of earnings. This means when you invest in a company with a good dividend payout history, you are enrolling for a relatively stable source of income.
  • Reinvestment: Companies often offer shareholders the opportunity to reinvest their dividends. This means instead of receiving the dividend amount, you can choose to reinvest this in the stocks of the company which will yield a compounding interest over a period of time.
  • Capital appreciation: A difference in the buying price and current market price of stocks leads to an increase in the initial capital invested by a buyer. This is called capital appreciation. When stock prices go up in the stock market, stockholders are benefitted.

See Also: What Is Dividend Yield? How To Calculate Dividend Yield?

How to Invest in Dividend Stocks?

Before investing in a company, you need to make a thorough study of the company. The dividend payout history will help to understand the stability of the firm. A close look at the financial statements of the company such as the balance sheet will serve the above purpose. Also, you need to focus on those dividend stocks that return a high dividend value.

To invest in dividend stocks, the following steps have to be followed:

  • Open a Demat account and trading account with any broker of your choice. The broker has to be registered with the stock exchanges. A number of online brokers are available these days like Zerodha, upstox etc. Demat account is just like a bank account, where all the shares you buy will be transferred to this account. Trading account is an account via which buying and selling of shares will take place.
  • Research about stocks. And make a list of the stocks you would like to invest in.
  •  Learn about a company’s past, present as well as future. For eg: A company that is planning to enter a new market can prosper and therefore increase its dividend value.
  •  Start buying and selling stocks via your broker.
  • It is not a must that dividends have to be paid. Companies can choose to lower or eliminate paying out dividends due to financial or economic crisis. Therefore, keep a close track of the company’s current happenings.

See Also: Stock Dividend vs Cash Dividend: Which is the Best?

How Dividend Stocks Generate Revenue?

Dividend stocks generate revenue in two ways. One in the form of dividend payments. And second in the form of capital appreciation as mentioned above.

Further, these two streams of revenue can be increased. Reinvesting will result in the growth of the company and leads to a higher dividend payment. Also if the share price goes up the value, capital appreciation occurs.

The advantage of investing in dividend stock is that, even if capital appreciation doesn’t occur, there will be a tiny, steady flow of earnings in the form of dividend payouts. This, when accumulated, generates revenue.

See Also: What are the Types of Dividends?

How to Identify the Best Dividend Stocks and Buy Them?

After knowing the basics of dividend stocks, it would look like an attractive and simple means of wealth creation. But just like any other investment, this one also requires hard work and time. You need to do systematic research about the company. You need to observe the stock market prices on a regularly. A few things to keep in mind while choosing a dividend stock are:

  • A steady flow of profit. Only companies with reliable profitability can yield steady dividends.
  • Focus on companies that have a culture of dividend growth in the past. This means they are likely to boost the dividend value in the  future as well because dividend growth attracts investors.
  • Monitor the industry. The company also monitors the industry in which the firm operates. If you invest in an industry that is declining, every company in that particular industry will be facing a hard time. And this, in turn, affects the stability and profitability of the company. For eg: investing in the digital industry would be a great option in this digital era.
  • Debt. Do not invest in companies that have a huge debt. This can be understood by looking at the debt-to-equity ratio of a firm. If this ratio is high, then it is better not to take the risk of investing in such a firm.
  • Low and steady earnings should be your priority. Do not focus on high returns as this involves risk.
  • Compare companies in the same industry. This will help you narrow out your list. If a company has a high dividend value compared to other companies, it is likely that the company would go for dividend cuts (reducing the dividend value).
  • Learn the financial statements especially the balance sheet. The balance sheet is nothing but the list of assets, liabilities and equity shareholders of a company. This will give a broad understanding of what the company owns as assets, and what it owes as liabilities.

See Also: Should you invest in Dividend Yield Funds?

Are Dividends Taxed?

In India, dividend stocks are tax-free. Yes, you heard it right. This means the shareholders need not pay anything in the form of tax on the dividend received. This makes dividend stocks, even more, attracting to investors!

However, companies are supposed to pay 15% tax on dividends in the name of DDT. DDT is the dividend distribution tax. They deduct this amount from dividends before paying it out to the shareholders.

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