Unlike the interest income from a bond or fixed deposit, dividend income is not certain. Like mutual funds, a company is not under any obligation to pay dividends or sustain the payout ratio. It is entirely at the discretion of the board of directors of a company to declare a dividend.
CHECK THE FACE VALUE OF A SHARE
The percentage of dividend declared by a company is based on the face value of a share. If the face value is Rs. 10, a 20% dividend would imply a payout of Rs 2 per share. If the stock has split and the face value is only Rs. 2, a 60% dividend would translate into a payout of Rs 1.20 per share.
TRACK PAYOUT RECORD
Don't buy only on the basis of the current high yield dividend. The company could have earned an extraordinary income and is, therefore, giving out a one-time high dividend. Check the dividend record for the past 4-5 years as well as the quantum of the payout.
EXAMINE CASH FLOW
One way to ascertain if the company can sustain its dividend payout is to look at the cash flow. Pay close attention to the cash flow in its balance sheets for the past 4-5 years. After accounting for capital expenditure, the amount left is the cash flow available to the company to buy back shares or pay dividends. The bigger the free cash flow, the greater the probability of dividends.
DIVERSIFY TO BE SAFE
If you depend on dividend income, don't keep all your eggs in the same basket. Diversify across a portfolio of 8-10 stocks. In this way, even if one or two companies don't pay dividends in a year, you would have income from 7-8 stocks. It's best to have sectoral diversification too even if this means settling for a lower dividend yield.
KEEP IN MIND CHANGES IN TAX TREATMENT
Right now, the income from dividends received from companies and mutual funds is tax free. However, the new Direct Taxes Code, which is expected to come into effect from 1 April 2012, has proposed a 15% tax on dividend income. Unlike in mutual funds, where the investor can opt for the growth option to avoid paying tax on dividends, stock investors cannot avoid this income or the tax on it.
DIVIDEND YIELD FUNDS
These are diversified equity funds that focus exclusively on dividend yield stocks. Not surprisingly, dividend yield funds have been out-performers in the past few years. They have given an average return of 24.5% in the past three years compared with 17-20 % by diversified equity funds. These funds offer investors all the benefits of dividend investing except for a regular income. For that, an investor will have to either opt for a dividend option or setup a systematic withdrawal plan.
Source: www.wealth. economictimes.com
Thanks,
Gaurav Agarwal
Head Dealer
DENIP Consultants Pvt Ltd
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