Should you invest in stocks offering high dividends?
The recent announcement of a dividend of ₹58 per share at Bharat Petroleum Corp. Ltd, a divestment candidate for the Center, has the stock market excited. But investors who are excited about high dividends should consider a plethora of metrics. Mint brings you ups and downs.
How do you know if the dividend is high?
Investors typically compare the dividend to the stock price. The dividend per share divided by the price per share gives you the dividend yield of a company. The dividend yield gives you a rough idea of the income stream you will get from investing in the stock (if the dividend is maintained in future years) and investors often compare it to other income streams such as the rent or interest. Note that dividends are declared at the discretion of the company and that there is no contractual obligation behind them like rent or interest. Sometimes the dividend yield is high because the market anticipates a drop in earnings and built it into the stock price.
What does a high dividend yield mean?
Investing in stocks with high dividend yields is popular, especially among “value investors”. A high dividend yield can mean that the stock is undervalued and investors can receive stable income even without the stock appreciating. In fact, there is a whole sub-category of mutual funds called dividend yield funds. However, there are caveats. Companies that pay high dividends generally tend to be mature players in their industries, with little other means of investing cash. High dividends may indicate a lack of room or ideas for expansion.
What is the tax situation on dividends?
Historically, dividend tax was paid by companies through the dividend distribution tax (DDT). This was abolished in the 2020-2021 Union budget. Starting in FY 21, investors had to pay a dividend tax based on their slab rate. So a 10% dividend yield translates to an after-tax yield of 6.88% for a person in the 30% tax bracket (including tax).
Is there a tax-efficient way to invest?
Yes, investing in such companies through mutual funds offers a distinct tax advantage. Mutual funds are structured like trusts and pay no tax on the dividends they receive. This dividend is added to the net asset value (NAV) of the fund. Dividend funds focus on buying stocks with high dividend yields. If you opt for the mutual fund growth plan, you do not have to pay tax on this growth in net asset value until you actually redeem your investments in the fund.
What About Mutual Fund Dividends?
Dividends declared by mutual funds are very different from those declared by companies. The former may involve the return of your invested capital as well as profits and the Securities and Exchange Board of India has required fund houses to call them “income distribution and capital withdrawals” from April 1, 2021. Dividends from Mutual funds are also taxable at your gross rate, making them tax inefficient for high earners. And you can’t predict when the fund will declare such dividends.
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