High dividend stocks provide consistent income to the investor over a while and less affected by market volatility

There are two ways one can make money by investing in stocks. When the stock prices increase, one can sell the stock at a higher price; the other way to make money from stocks is when the company pays dividends.

Dividends refer to the cash a company distributes to its shareholders from its profits. The company may decide either to pay dividends to its shareholders or to reinvest the profits back into the business. They may also use the profits to pay back debt. This decision is taken by the board of directors of a company. It then needs to be approved by the shareholders. Dividends are paid quarterly or annually. So when you own high dividend stocks, you can earn an income just by holding a stock. You can also benefit when you sell these stocks when their prices go up.

Naturally, high dividend stocks are in demand. But what qualifies as a high dividend stock?

Here, we need to understand the concept of dividend yield. The dividend yield is calculated as a percentage of the stock price, using the below formula:

Dividend yield= Annual Dividend / Stock Price X 100.

If a stock is worth Rs 100 and it pays a dividend of Rs 5, the dividend yield is 5 percent.

Stocks of companies that have a higher dividend yield when one compares it to the benchmark are known as high dividend stocks. Typically, there is no such benchmark, but shares with a dividend yield of more than 4-5 percent can be called high dividend stocks. High dividend stocks are also referred to as best dividend stocks.

Why invest in best dividend stocks

Best dividend stocks are a hit with investors because of the following features:-

Best dividend stocks provide a consistent income: These stocks offer regular dividends to investors. They can help investors generate revenue for the entire time they hold the stock.

Best dividend stocks can be used by investors to boost their investments: The dividends earned can be reinvested into the stock markets by the investor to make more money. Investors can also use this money to fund their retirement or other long term goals. Investors who are nearing retirement or are already retired may also choose high dividend stocks as a means of a regular income.

Best dividend stocks are relatively free from market volatility: Most of such stocks are in defensive sectors. These are sectors which are non-cyclical and are not dependant on economic cycles such as energy, real estate, utility and consumer goods. Even when the economy is unstable, these stocks generally deliver value. Such stocks are less volatile as compared to the overall markets and hence are suitable for investors with lower risk appetite. Although stocks can generate high capital returns, dividend income is more stable and predictable. High dividend stocks tend to make more returns than Government securities and are hence a good investment option.

How to pick best dividend stocks

The following needs to be kept in mind when selecting the best dividend stocks.

  1. Look at the company’s financials: Study a company’s financials carefully. A  company’s balance sheet will give an idea of its assets and liabilities. If the debt to equity ratio is too high, it means that the company has a large amount of debt, and at some point, it will look to pay the debt. This would affect the dividend payout.
  2. Choose companies with a reasonable payout ratio:The dividend payout ratio refers to the percentage of a company’s earning that is being paid out to investors as cash dividends. If a company is already a large one and not looking to grow anymore, then most of the profits it is making are paid out as dividends. Though there are no benchmarks for the dividend payout ratio, investors who are looking for dividends would look at a high payout ratio of 40-50 percent. If the company has a low payout ratio, it is not a good sign. However, a very high dividend payout ratio is also not a good thing. A payout ratio of above 80 percent means that a company is exhausting all its income in paying dividends. Such a company is likely to cut dividends when there is a fall in earnings.
  3. Look for companies with a track record of consistent dividends:  Best dividend stocks will have a consistent track record of paying dividend to its shareholders. So check the company’s history for the last 5-10 years and select those that have been paying steady or increasing dividends.
  4. Beware of companies with very high dividend yields: It may sound counterintuitive, but one should stay away from companies that have very high dividend yields. Very high dividend yields could mean that stock prices of the company have dropped rapidly during the same period. So companies that have a stable dividend yield are better.
  5. Consider the business and industry: Consider the sector where the company belongs to as long as the industry is a fast-growing one, the chances of dividends increase. However, it is essential not to pick a stock based on history as the growth rate in an industry may change over time.
  6. Look for companies that have a healthy cash flow: Sometimes, companies may have high accounting profits, but they may suffer from poor cashflows. Such companies may find it difficult to pay dividends. While small companies may have a cash flow issue, large and stable companies should have a steady positive cash flow.