Dividend stock: Stocks with high dividend yield often attract heightened investors interest, but can it become a sole metric to add one in your portfolio? Dividend yield is the percentage of annual dividend paid by a company to its stock price, and indicates how much dividend income you earn relative to your investment.
“High dividend is attractive; however, the durability of the dividend is what matters,” explained Pankaj Pandey, Head of Retail Research-ICICI Securities, while adding that it can’t be the sole criteria for a stock selection. So what are the other key factors investors must consider before choosing a stock for investment and dividend? Let’s understand from the expert.
Can high dividend yield be a compelling reason to pick a stock?
Dividend yield could be one of the factors to choose a stock for portfolio, but picking one only on the basis of that wouldn’t be a wise decision, according to Pandey.
“High dividend yield in absolute terms should not be the sole criteria for stock selection. Dividend yield could be the starting filter, not the investment thesis,” noted the expert.
What else should dividend hunters look for?
For investors who want to add a dividend paying stock in their portfolio, Pankaj Pandey, highlights that a host of other factors would also matter.
A useful mental model can be: Expected shareholder return ≈ Dividend yield + Earnings growth ± Change in valuation multiple.
Earnings growth
Look for how the company has performed over the past few quarters, three month-periods for which it reports revenue, expenses and profit/loss. Firms also release other information like debt ratio, business growth, etc.
Valuation multiple
The metric indicates how much investors are ready to pay for the same amount of a company’s profit. Price to earnings ratio (P/E) can be a key indicator of valuation multiple.
Business growth
Evaluating overall business growth in terms of its capital efficiency, cash flow generation, runway for growth, balance sheet strength, and valuations would ensure real gains from investment.
“Suppose there is this Company A which offers a 7% dividend yield but has no growth and mediocre incremental returns. Now there is Company B which offers only a 3% yield but can reinvest its retained earnings at 18–20% ROCE and compound earnings for the next decade. In that case Equity markets will reward Company B and not Company A. Company B will turn out to be a superior investment in our opinion,” explained Pandey with an example.
