Friday, August 22, 2008

Can dividend yield stocks make you rich?

A typical market reaction in times of a downturn is that investors start scouting for safer investment avenues. And it?s no different this time, round. Investors are shifting focus to high dividend yield shares.

What are Dividend Yield Stocks?

These stocks offer a high dividend payout in comparison to their share price. In the Indian market, one can find such stocks usually amongst Public Sector Units.

In other words, the dividend yield is the latest dividend declared per share/ current market price.

USP of companies that issue Dividend Yield Stocks:

They are usually stable and have a history of consistent profitability, and a dividend payment track record.
In case of a market crash, the share price of these companies is likely to fall less in comparison to the so-called growth stocks, thus making them comparatively low-risk defensive stocks.
If inflation is controlled, we may see interest rates moving downwards, over the next 6 to 12 months. Thus the dividend yield may even work out more than bank interest rates.
These companies have the potential for capital appreciation (medium to long term) once the markets recover. So, you can expect to earn a decent recurring income and capital gains over time.
Big Question - Does the dividend yield theory work?

Maybe. Or maybe not! You don't necessarily have to buy stocks of a company that has a high dividend yield. But you need to know if the company can continue its dividend paying track record.

To understand this check the following:

Does the company?s business earn stable income and profits? Will it continue to do so in the future, too?
Make sure past dividends have come out of business profits and not some extraordinary items.
Does the company have a policy to consistently pay out high dividends?
Lowdown on Dividend Yield Mutual Funds:

These have not performed well, so far. Here's why:

The last few years has seen an appreciable rise in shares prices. This means fewer opportunities for dividend yield funds to invest their money in.
Growth stocks have done phenomenally well in the last few years dwarfing the returns from dividend yield stocks.
There is the problem of illiquidity, as these scrips are less sort out.
It is difficult to sell illiquid stocks. So, MFs may be forced to sell liquid stocks, which may affect the portfolio performance.
Not only have these funds underperformed but they have not managed to restrict the loss in the recent downslide.

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