Investments have now become a vital part to ensure a secured future in today’s world. While it is a well-known fact that if one remains invested in a company for the long term, high yields are bound to take place. But other than that, how else one can profit from investing in a company? Some of the benefits that can be availed are Dividends, bonus, rights issue, etc.
A company may either opt to reinvest the profit it generates or share a portion of it via shares. The reward that is extended to the investors is termed as a dividend. Retail investors who are seeking a steady source of income from the stock markets look to invest in companies that extend steady dividends as well as have promising growth potential. Stocks of such businesses are called high dividend yield stocks. The concept of dividend yield and more about these stocks is covered in detail below.
In this article
What are Dividends?
Dividend is the portion of profit distributed by a company to its shareholders from its earnings. The company may either decide to reinvest its profits in business as well without providing any dividends to the shareholders. The dividend is decided by a board of directors of the particular company and has to be approved by the shareholders as well and are paid quarterly or annually.
What are High Yield Dividend Stocks?
To understand these stocks and their functioning, it is imperative to understand ‘dividend yield.’ The term dividend yield describes the income that investors would be disbursed against the current price of stocks they have invested in.
It can also be described as the ratio of the bonus paid per share and the current market value of the shares. The ratio is calculated through the below-mentioned formula, and the outcome is expressed as a percentage.
Dividend Yield= (Annual Dividend / Share Price )x 100
Typically, stocks that generate a higher dividend yield when compared against a specific benchmark are known as high dividend-paying stocks.
Investors benefit from investing in high dividend yield stocks as dividends can then double as a steady income source for investors. Dividends earned passively are often reinvested by investors in the stock market to make more money. Alternatively, investors can utilise this income to start funding for their retirement or other long term goals they wish to accomplish. The benefits of dividend-paying stocks are the profit that investors gain via share price appreciation as well as through the distributions received.
To ensure that the shares they want to opt for are the best dividend stocks of high quality, investors should judge them based on the following –
- Their consistency in paying a dividend.
- The consistent growth in the percentage of dividend.
What is the Dividend payout ratio?
Dividend ratio is defined as the percentage of the net income distributed as dividends to its shareholders. It is not advisable to invest in a company whose dividend payout ratio is more than 100% as the business can bear loss in the long run.
Features of High Yield Dividend Stocks
- Regular earnings
- Less susceptibility to major economic cycles
Reasons to Invest in High Yield Dividend Stocks
The benefits that come along with the features of High Yield Dividend Stocks serve as potent reasons for individuals to invest in High Yield Dividend Stocks.
Here are a few other benefits those appeals to the investors –
- Consistent income: Best dividend stocks offer regular dividends to the investors. Such regular pay-outs serve as an opportunity to generate consistent income for the entire investment horizon. Additionally, most dividend yield stocks generate greater returns, which tend to improve over the long run.
- Investment portfolio enhancement: Investors can use the income generated from a high dividend shares to build a corpus to fulfil their financial goals. However, individuals also have the option to reinvest the dividend into other investment options like Mutual Funds to help diversify their portfolio.
- Volatility: Most companies who extend dividends to their shareholders belong to the defensive sectors. The fact that such sectors are not entirely dependent on major economic cycles makes it less susceptible to market volatility, thereby, making their high yield dividend shares less volatile and suitable for investors to have moderate risk undertaking capacity.
Associated Risks of Investing in High Yield Dividend Stocks
The following are a few risks of such risks that are associated with them –
- Even the best dividend stocks are subjected to market changes. When the market is underperforming companies may decide to reduce their dividend output which may directly affect their stock prices of high dividend yield shares negatively.
- Another risk associated with such stock options is that dividend offering companies may opt to reinvest their entire profit into their business. Such a move will be looked at as a loss for investors who invested in high dividend shares to earn greater dividends in the first place.
- Often the act of offering a dividend to shareholders is looked at as lacking on the part of such companies. It is seen as a lack of reinvestment opportunities and scope of business expansion for them.
Alternative Investment Options
Risk and reward go hand in hand when it comes to investing in high dividend paying stocks. Individuals should also acknowledge the risk factor associated with such investment options.
If investors want to improve their scope of earning while exposing themselves to little to moderate market risks they can explore these following investment options –
- Gold ETF
The said commodity ETF can be traded on exchanges and are susceptible to the market prices and performance of gold bullions. They are more liquid when compared to physical gold and accrues better returns.
- Sector Funds
The said funds, invests entirely in specific sectors of the economy and is commonly structured as Mutual Funds or ETFs and are suitable for long-term and mid-term investments.
Many investors invest in sector funds as a part of their strategy to allocate resources evenly across industrial sectors for generating better earnings and lower risk burden.
- Funds of Funds
This particular Mutual Funds scheme invests money into other Mutual Funds options. Investors have the opportunity to choose from a diverse investment portfolio that suits their risk capacity and helps achieve their financial goals.
Investors can go for high dividend yield stocks if they have a slightly less risk profile and are looking to earn a steady income from the stock market. However, it is a common observation that companies which pay a high dividend have peaked their growth potential and their possibility to expand across sectors is limited. Consequently, investing in high dividend yield stocks doesn’t make sense for investors who are eyeing rapidly growing companies. This is because businesses who are still in their high growth phase will reinvest their profits to expand further instead of giving dividend payouts to shareholders. A word of caution – investors must carry out the due diligence and make sure they are fully aware of the investment risks, their own risk profile and investment objectives, before selecting the best high dividend yield stocks to invest in.