FAQs on how and why dividends matter for investing
1) What are company dividends?
Dividends are a regular payment by the company from the accrued profits or from the sale receipt of any assets of the company. Dividends may be interim dividends, which mean that they are an initial payment of dividend ahead of the full-year dividend that a company will pay or a final dividend, which is the final installment of the yearly dividend that a company would pay.
2) What is the usual frequency of a dividend?
Dividends can be quarterly, half-yearly or annual, depending upon the comfort that the company has in paying dividends. The main factors that could influence the frequency of dividend payments include the nature of the business the company operates in (for example, a company that is a power utility has regulated rates for its revenue and has more predictable cash flow, and may pay quarterly dividends), the ownership structure of a company (for example, government-owned companies tend to pay dividends more frequently as they need to support the government’s revenue objectives).
3) What are dividend yield and dividend payout ratios?
The dividend yield is calculated by dividing the dividends received by a company over the last one year by the current market price of the company. For example, the dividend yield of ITC is slightly less than 5 per cent – Rs 10.15 divided by Rs 208. Meanwhile, the dividend payout ratio is the percentage of annual earnings per share (EPS) that a company pays out in terms of dividends. Mature companies like ITC could pay close to 100 per cent of their annual EPS in the form of dividends, while high-growth companies, which can find better opportunities for re-investing their annual earnings, will have lower dividend payout ratios.
4) How can one use dividends to help determine their investment strategy?
One size does not fit all when it comes to dividend investing strategies. When it comes to larger established companies, these organisations have long-term dividend-paying track records. One of the important criteria to use when evaluating a company paying dividends is to compare the growth in dividends to the growth in earnings to assess where the company may be in its growth cycle. Mature companies usually have higher dividend yields relative to the overall market and also have higher dividend payout ratios. When a company pays a very large dividend relative to its earnings per share, over the medium-term, it may indicate that the company does not have great long-term growth prospects. A suitable investment strategy may be to use the dividend payout ratio. Ideally, the dividend payout ratio could be in a range of 30 to 50 per cent over the medium term to select a company for further analysis.
5) What are some of the companies that are providing a high dividend yield within the large-cap established companies?
Currently, ITC has one of the highest dividend yields. Other companies that offer attractive dividends yield include Power Grid Corporation, Bajaj Auto, and GAIL. However, one also needs to analyse the medium-term growth prospects for these companies before considering them for investment.