If you think that a stock can either appreciate or depreciate your capital only, you must get your facts right. A stock can be a wonderful way to earn even a regular income. This regular income takes place in the form of a dividend. Actually, dividend is a portion of a company’s profit that it shares with it shareholders. So anybody holding a dividend stock also earns a passive income out of it apart from the capital gains. However, the big question is, how to zero in on a dividend stock? Not all stocks can earn up good regular income.
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Selecting dividend stocks
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Dividend payout ratios
It is important to look at the ratios, especially dividend payout ratio. Dividends are paid out of the profits of the companies’, so profitability of the company must be considered. You must see how much is paid back to the shareholders. The lower the ratio the more secure the dividend. This is because if the earnings go down like in the period 2008-09, paying smaller dividends can be adjusted upon. In such a scenario the investors remain protected. In case a company pays out more than its earning, it could be due some asset sell off. This doesn’t make up an issue. However, if a company is borrowing money to pay the dividends, that’s really alarming and an investor should be cautious.
A company’s past dividend record is worth looking at. You must see if the company can continue paying dividends in future as well. If the company has been paying dividends over the past five, 10, 15, or even 50 years are likely to continue the trend. A company’s dividend payment history along with annual growth is a good way to compare, and select out dividend companies. You remain protected against inflation too. However, a sudden large increase, say from 2% to 6%, over a short span of time such as a year or two, may turn out to be unrealistic and unsustainable into the future.
Stable product line
It is important to have a stable product line of the company. A company may be in the business of beverages or computer, but the need for that product should be worldwide.
A dividend-paying company should have good cash flows. Look at the current ratio. It measures the company’s ability to meet short-term obligations. It is the ratio of current assets to current liabilities. If the current ratio is greater than 1, the company can be said to be in good shape.
Stick to core business
It is always good if a company sticks to its core business. Even if the company wants to expand, it makes more business sense to remain in the same area. Like a pharmaceutical company acquiring a smaller drug company remains rooted to its core business. It is important for a company to maintain its competitive edge. Therefore it is essential to know what it is good at and stick with it.
It works in the advantage of the company if it also buys back its shares. It essentially means that it has enough earnings to pay dividends as well as buy back the stock.
You must factor in the dividend yield of any company you’re considering to invest. It is calculated by dividing the dividend by the share price. A dividend yield of 2-3% per cent is must. In tough times, the dividend yield goes up as the share price goes down and in good times it goes down due to increase in the price of shares.
Are you entitled for Dividends?
You might buy a stock only to find out later that you were not entitled to the next dividend paid by the company. This happens because you have not kept track of the dates involving dividends. To determine whether you should get dividends, you need to look at two important dates. They are the “record date” and the “ex-dividend date”. The ex dividend date is the one when a share trades without dividend. If you buy a share on ex-dividend date, you are not entitled for the dividend. However, if you sell a share on this date you still get the dividend. So in order to be entitled for the dividend you must buy a share before ex-dividend date.
Another date is record date. This is the date when your name must be in the books of accounts of the company as shareholders. Usually, record date is two days after ex-dividend date. It means the shares purchased by you must be credited to your account on that day. In India T+2 days settlement is followed. Suppose on April 21, 2013, company ABC declares a dividend payable on August 31, 2013 to its shareholders. ABC would announce the record date as August 10, 2013. Then the ex-dividend date would be two business days before the record date i.e. 8th August 2013. On 8th August the share would trade without dividend. If the record day happens to be a Tuesday, then the ex-dividend day would be Friday.
On ex-dividend date the share falls by the amount equal to the dividend. Suppose a company pays dividend of Rs 2 per share. The share would fall by approximately Rs 2 on ex-dividend date.
Types of Dividends
There are mainly two types of dividends in India-cash and stock. As the name suggests the cash dividend is in the form of cash. Usually it is transferred to the bank account of the shareholders via NEFT. However, a company can pay a dividend in the form of stock rather than cash. The stock dividend may be additional shares in the company or in a subsidiary being spun off.
Dividends are generally paid once a year and decision regarding them takes place at the annual general meeting of the company. But some companies also pay dividend more than once a year. These are called interim dividends. Actually, they are payouts that are doled out between the two annual general meetings of the company. Sometimes they take place more than once a year apart from the final dividend. Take for instance, Punjab National Bank. In February 2010, it paid an interim dividend of Rs 10 per share and on in July 2010 a final dividend of Rs 12 was doled out.
Under section 10(34) of Income Tax Act 1961, dividend paid out by the Indian companies is tax free in the hands of the shareholders. So you need not pay any tax on the same. At the time of filing the return, the same has to be shown in the form of exempted income. So what are you waiting for? There are many good stocks that pay good dividend. Select them with the above mentioned criteria and enjoy a regular income.