Equity shares of a company that disburses dividends to its shareholders at consistent intervals are considered as dividend yield stocks. These dividends are either paid out in the form of cash or additional stocks of the company.
These companies are usually large-cap companies or blue-chip organisations. In India, companies that have a market capitalisation of Rs. 20,000 Crore or above are considered as large-cap companies, while blue chip organisations are the top 50 companies listed in benchmark indices operating.
These businesses disburse the larger portion of their yearly revenues as dividends to their shareholders, and the remainder of such revenues is reserved as retained earnings for reinvestment in growth projects. Such consistency in dividend payments enhances their credibility and goodwill amongst investors.
The primary reason why large-cap companies can explicitly issue top dividend yield stocks is these companies are at the peak of their growth phase and require less finance for further growth and expansion.
At the same time, they can maintain consistency in the payment of dividends irrespective of relevant market conditions due to their stable financial, organisational, and operational capacities, allowing them to withstand sizable market fluctuations.
In this article
Features of Large Cap Companies
- Sustainable Dividend Pay-out Ratio
The dividend pay-out ratio is denoted in percentage and is derived by dividing the total dividend a company pays out annually by its yearly revenue or cash flow. In other words, it is the percentage of annual revenue a company disburses as dividend to its shareholders.
Dividend Pay-out ratio = Total dividend x 100/Annual revenue
For instance, a company if a company reports annual revenue of Rs. 500 Crore, and distributes Rs. 200 crore as a dividend its dividend pay-out ratio can be calculated as follows –
Dividend pay-out ratio = (200 crore / 500 crore) x 100 = 40%
A large-cap company that issues dividend stocks usually has a sustainable dividend pay-out ratio; which means it distributes its earnings in such a manner to be able to pay dividends timely while at the same time maintain enough reserves to withstand any probable economic downtrends in the market.
- Dividend Growth
One of the most significant features of large-cap companies is a consistent increase in their revenues or cash flow over time, which is usually accorded with inflation.
- Industry Leaders
Businesses or companies that issue dividend stocks also have a growing earning per share. It is because these companies are usually industry leaders and enjoy the trust of consumers. They, hence, have competitive advantage which allow them to deliver quality products at increased prices.
Benefits of Dividend Yield Stocks
- Periodic Returns
As mentioned earlier, shareholders of dividend stocks earn dividends on their shares at regular intervals. Also, such companies retain a considerable portion of their revenues as Reserves which allows them to continue paying periodic dividends even through a market slump, ensuring consistency in dividend payouts.
- Minimal Risk
Dividend stocks carry nominal risk when compared to other market-linked financial instruments. This can be attributed to a stable financial and operational infrastructure of large cap companies to maintain dividend payments, even during market downtrends. Additionally, prices of such shares remain relatively stable over time. Hence, investors do not run the risk of losing their capital or bearing loss on dividend yield stocks.
Businesses that issue the best dividend yield stocks are usually market leaders; hence, they have a competitive advantage in the market allowing them to regulate the prices of their products at par or above the inflation rate. Resultantly, they can also afford to distribute dividends which are in tandem with inflation in the economy.
Limitations of Dividend Stocks
Given the fact that dividend yield stocks are issued by large-cap companies, prices of such stocks are sizably higher. As these stocks pose as a dependable and regular source of income while also allowing investors to hold stake at a reputed company, shareholders tend to sell them at higher prices.
- Low Capital Gains
Even though holding dividend stocks fetches regular and assured dividend yields in the stock market, they are not suitable to earn substantial capital gains. It is because these companies are usually at the prime of their growth phase and do not have many prospects for further growth. Subsequently, prices of such stocks remain relatively stable in the market and shareholders do not realise high capital gains.
Taxation of Dividend Stocks
Two types of tax are levied on dividend stocks – Dividend Distribution Tax (DDT) and capital gains taxes. The Dividend Distribution Tax is paid by the company that is distributing the dividend, on behalf of such shareholders. In other words, investors receive their dividends after DDT has been deducted from it.
Currently, a 15% DDT is levied on dividends along with surcharge and cess, which effectively brings up the tax rate to 20.56%. Other than DDT, investors that have dividend earnings over Rs. 10 lakh are required to pay an additional 10% tax on their dividend income.
Capital gains tax is paid on the profit which investors earn upon selling stocks in the market. If dividend yield stocks are sold before 12 months of holding it, a 15% short-term capital gains tax is levied on such capital profits. On the other hand, if an investor sells their dividend stocks after 12 months of holding it, they need to pay a 10% tax on their long-term capital gains tax if such profits exceed Rs. 1 lakh.
Who Should Invest in Dividend Yield Stocks?
Investors who are seeking to secure a steady source of income by investing in equity shares shall invest in dividend stocks. This allows them to earn regular income in the form of routine dividend pay-outs while also assuming stake at a reputed company. Ergo, it is an ideal investment route for investors who are new to the stock market.
It is important to note that the primary source of income from this type of stocks is dividend pay-out. Hence, investors explicitly with long-term investment objectives shall opt for dividend yield stocks.
Experienced investors can also choose to include dividend funds in their investment portfolio to attenuate the risk factor. Dividends earned from such stocks would allow such investors to compensate for losses from other riskier investment options during an economic downturn.
However, before individuals choose to invest in dividend yield stocks, they should consider a company’s dividend payment history, its financial performance over the past few fiscal years, and its dividend payout ratio. It shall be noted that companies with a lower dividend payout ratio have higher chances of sustaining market turmoil and hence are more dependable in terms of routine dividend pay-outs.