Due to two key factors, equity investing has grown in popularity among investors throughout time. First off, it acts as a straightforward and incredibly practical form of investment. Second, equity is a hybrid form of investing. In other words, long-term equity investors stand to gain from the two types of returns provided by equities. First, they provide regular income to investors in the form of dividends. Second, investors profit when the value of their shares rises gradually over time; this is referred to as a capital gain or capital appreciation. The majority of investors, almost to the point of obsession, prefer capital gains as their preferred mode of return. However, due to the focus on equity market capital gains, we often overlook dividends as a different component and a different type of return. Therefore, I’m going to discuss how dividends can be just as attractive a form of return as capital appreciation is, if not more so, in today’s post. Let’s first get a fundamental understanding of what dividends are before moving on. Equity shareholders are first and foremost owners of the businesses whose equities they hold. Additionally, because shareholders are also owners of a company, dividends are a portion of company profits that are distributed to shareholders in exchange for their ownership of the business. Buying stocks that consistently pay dividends is undervalued and occasionally even ignored. However, if used properly, dividends can be used to significantly increase the returns on our equity investments. On the face value of a company’s shares, dividends are paid. And their primary sources of income are these two: ° The company’s post-tax earnings per share of its stock ° Unrestricted liquid cash in hand that the company has on hand Let’s now examine how dividends increase our equity returns. Take into account the information below for a hypothetical investor who owns 1000 shares of a particular stock and a constant dividend payout ratio of 50% of annual EPS. Therefore, even though the payout ratio remains constant at 50%, the investor would receive dividends worth Rs 5,000 in the first year, Rs 7,500 in the second year, and Rs 10,000 in the third year. This is due to the company’s ability to continually increase its profits and EPS from one year to the next. There is a different school of investing that advocates assembling and maintaining a portfolio of these businesses that consistently increase their earnings and dividend payments. Investing in dividend growth is what this is called. An important factor in determining the returns form and quality of stock is dividends and the sustainability of dividend payouts. This is due to the fact that businesses can only consistently declare dividends when earnings are high and cashflows are positive. The fact that a company’s dividend payments are a result of its corporate policy rather than how the market perceives the company is another great thing about dividends. On the other hand, capital growth is reliant on both the company’s fundamentals and the market’s perception of its stock, both of which may change over time. Dividend returns are therefore a more reliable estimate and a steady component of returns relative to capital appreciation. This is especially true when there is a downturn in the economy and stocks and markets as a whole perform poorly. Dividends act as a buffer for investors in these situations, reducing the impact of falling stock prices. Although dividend payments may initially be modest, reinvesting dividends into more shares of the stock that paid the dividend grows our ownership of the stock and entitles us to larger dividend payments in the future. The final capital gains from the underlying stocks would also be amplified by reinvestments. As a result, dividend reinvestment is a key factor in stock returns. Look at the information below, presuming an investor owns 1000 shares of a firm that consistently pays a dividend of Rs. 10 each year, to get a better understanding of this. The important thing to note in this situation is that the investor always reinvests all of his dividends at the current market price, increasing his shareholding and dividend income with each passing year. Also observe that even in year 4, when the market price falls to Rs 150, he continues to receive the same dividend per share. In times of inflation, dividends also preserve the purchasing value of our money. Because we would have to pay more for the goods and services we use, inflation is negative for us as individuals. However, since businesses are likely to increase the selling prices for their goods and services, inflation benefits them. Price increases translate into higher profits, which in turn translate into higher dividend payments. This resolves one of our main concerns during inflationary periods by indicating that the purchasing power of our money would not be significantly impacted. Dividends were previously entirely tax-free for stockholders. However, a recent decision by the Indian government has made dividends received after 1 April 2020 subject to appropriate slab rates of taxation in the hands of shareholders. Evidently, this detracts from the appeal of the possibility of getting dividends. But keep in mind that dividends are assured cash payments that are credited directly to our bank accounts. And what’s not to love about having money hit our bank accounts in a cold, hard way? Better than having no amount at all is having a reduced amount after taxes are taken into account. as the tax component of any income is just that—a component. Saving tax on our investments is beneficial, but it shouldn’t turn into a fixation. Our investments are about far more than just reducing taxes. Furthermore, when profits are sufficiently substantial, they can be used to cover our living expenses. Recall that dividends are paid out using funds from our firms. Thus, after a certain point, our companies cover our costs. Show me a benefit of dividend stock investing that is better than that. By now, it should be obvious that dividends are not as dull and unappealing as they are portrayed to be. Furthermore, dividends are not without merit, even though financial gains on our assets are unquestionably thrilling and satisfying. And when it comes to boosting the returns on our equity investments, dividends have the potential to be even more potent than capital gains if used and channeled properly. Always buy a chicken for its eggs, a cow for its milk, bees for their honey, and stocks for their dividends, according to an adage in the investment world.
- GDP = Consumption +Investments + Government Expenditure + Exports – Imports.
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