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High Dividend Stocks

There are two ways in which an investor can profit from his investment in stocks.

One, through stock price appreciation, which we know can remain depressed for a long duration even if the fundamentals of the underlying company are strong enough.

Another way to profit from an investment in a stock is through dividends.

Dividends, unlike stock prices, do not depend on the whims and the fancies of the investor community at large. If the business is performing well and generating cash in excess of what is required for growth, dividends are paid out irrespective of the stock price movement.

Understanding Dividends with Examples

For a second, imagine yourself as a cattle farmer. You buy a cow, feed it and milk it to earn income from dairy products.

After two years, due to high demand of cows in the market, you sell it at double price.

That's how people earn in the stock market. They buy stocks at low prices, retain dividends (like the farmer earned from selling milk) and then sell them at high prices (like the farmer sold it after 2 years).

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So, the profit earned from selling high is capital appreciation profit, and the sum of money paid regularly by a company to its shareholders out of its profits is known as dividend profits.

These days, dividend paying stocks have become some of the most sought after entities in the share markets.

Dividend yield is analogous to the interest rate that you'd receive on a bank's money market or savings account. Your dividend yield is your next 12 month's expected dividends divided by the price you pay for the shares.

What Makes Top Dividend Paying Stocks So Likeable?

Dividend income is one of the most desirable passive income source. People who believe in it, also love stocks that pay dividends. Passive income in the form of dividend is like an assured income.

Also, one can take advantage of the tax break on dividends.

A company can do two things with the profits that it earns. It can either invest it back into the company (into reserves and surplus) and/or pay out the amount as dividend. As such, dividend payout depends a lot on the cash (after meeting its capital expenditure and working capital requirements) a company generates during a year.

It quite often happens that many companies will not need to reinvest much into the business (in spite of having high return on investments), purely because they don't see the need for it.

A classic example would be of companies from the FMCG sector. The FMCG sector is a slow yet steady growing industry. Most of the companies garner high return on their investments in this sector. But yet they choose to pay out huge dividends due to the sector's slow growing nature as capex requirements are on the lower side.

Now if we compare this to say a fast growing industry such as telecom, the situation is quite different. Telecom companies incur huge capital expenditure to spread its wings across the entire country.

Do all Dividend Paying Companies Make a Good Investment?

The answer is understandably no.

This is where the aspect of 'dividend yield' comes into picture.

Dividend yield is calculated by dividing the amount paid out as dividend within a year by the company's share price. An example will help in understanding this better.

Assuming a company's stock is trading at a price of Rs 100 and during FY19 it has paid a dividend of Rs 5 per share in total. This stock would be having a dividend yield of 5% at the current price. Assuming that the company is growing steadily and is expected to pay dividends in the coming year, the investor could have surety of earning at least a 5% return on his investment.

Does this mean any company that pays a high dividend becomes a good buy?

Absolutely not. Not all dividend stocks could be treated equal. When identifying the right dividend stock to invest in, here's a few things to keep in mind...

A good dividend stock should also be available at an attractive dividend yield. Now, this does not mean the higher the yield, the better the stock. On the contrary, a higher yield can be a result of an extremely beaten down stock price.

On the other hand, a very low dividend yield is not great either. A low dividend yield would mean a very high price, and thus, unattractive valuations. Such stocks may take years for the yield to become attractive at the price at which you bought the stock.

Thus, along with the strong corporate governance, good growth prospects and a healthy dividend policy are crucial for investing well.

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Get the Best Dividend Stocks with This Free Stock Screener

Finding stocks which fit the criteria of quality dividend yielding stocks has just become easier with Equitymaster's advanced screening tool.

Check out Equitymaster's user-friendly and free stock screener to pinpoint worthy dividend payers.

If you're not familiar with the term, stock screeners are software programs that allow you to scan the entire stock market for stocks meeting your selection criteria.

Here's the list of Best Dividend Yield Stocks as of financial year 2019.

Best Dividend Yield Stocks

SCRIP* DIVIDEND YIELD (%)
Himachal Futuristic 73.1
Tata Steel 58.8
Graphite India 41.2
Jain Irrigation  34
Vedanta 29.5
Dish TV 21.1
BHEL 19.2
Crest Ventures 17.3
NALCO 14.6
HEG 13.8
Container Corporation 13
Oil India 12.9
Hindustan Zinc 12.2
Procter & Gamble health 12
Banco Products 11.8
D. B. Corp 11.4
IOC 11.2
The Byke Hospitality 10.6
ONGC 10.3
Bajaj Consumer Care 10.3
National Fertilizers 9.9
Arvind Ltd 9.9
Bharti Infratel 9.6
Onmobile Global 9.5
Care Rating 9.2
Stock Screener results from Equitymaster's own database, which comprises India's leading 490 companies.
*Data is consolidated wherever applicable

Please bear in mind that these stocks should not be considered straightaway for investment. But the list does act as a good starting point to create a portfolio of good dividend stocks from a long-term perspective.

A Simple Checklist for Picking Great Dividend Stocks

There are some important points to keep in mind while selecting stocks for their rich dividends...

A good place to start would be to study how the company earns its revenues. Are its revenues stable or are they highly cyclical? For this, it is necessary to understand whether the business of the company is stable or volatile, cyclical, based on too much debt, etc.

Look for the stable business. Because if the company's own income is dicey, then its dividend stream will eventually follow suit.

The second question to ask yourself is how does the company manage to keep its cash flows stable and growing? In other words, what competitive advantage does the company enjoy that it will not only be able to keep its cash flows stable but also be able to grow them?

The competitive advantage helps the company build a safety moat around itself. This moat would protect the business from competition. And if the company is able to use its competitive advantage to widen the moat over time, then it is the perfect business to be in.

Another question is whether the company is able to grow its earnings or not. If it has stable cash flows and is able to grow them, then it should ideally follow that earnings are growing too.

But if the company is growing its earnings and not its cash flows, then it could be possible that it is manipulating its earnings. This could be risky. If cash flows don't grow, then it will be hard for the company to pay out a growing dividends stream.

The final question is the risks associated with the company itself. For this you need to question things like competition, management honesty, vulnerability to technological disruption, management's capital allocation skills, etc.

And of course, all said and done, a high dividend yield doesn't necessarily mean a good stock price.

You need to see whether the company is available at a cheap valuation compared to its fundamentals or not. For if you pay too high a price for a good dividend stock, then in the long term your returns would be miniscule, if not negative.

Only when you buy a good stock at cheap valuations will you able to maximize your long term wealth from yearly dividend flows to your bank account.

Investors would do well to use this checklist next time they want to buy stocks purely for dividends.

Once again, in a nutshell, to find good, high-dividend paying stocks - ask these questions:

  1. How does the company earn its revenues?
  2. How does the company keep its cash flows stable and growing?
  3. Is the company able to grow its earnings or not?
  4. What are the risks associated with the company itself?

But dividend investing is hardly this simple.

A company that borrows to pay you dividends is unlikely to add any value to your portfolio. Also, you can't just bet on the stocks with high dividend yield. You must make sure that these dividends will keep flowing.

The key is to bet on bargain stocks with solid fundamentals, that are led by competent and ethical managements, and offer healthy dividends too.

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