Why investing in high dividend stocks is a good bet

Investing in stocks involves a lot of risk taking, but investors who pick companies with strong fundamentals and have a long horizon, invariably succeed. Investing in high dividend yielding stocks is considered a safe bet by many analysts. That's because only those companies that are confident about future earnings and have strong cash flow tend to distribute dividends.

The capital appreciation in high dividend yielding stocks might be less, but investors are assured of a steady flow of income. Such stocks are an asset in one's portfolio when markets turn bearish. What's more, dividends are not taxed in the hands of shareholders, making them attractive for investors.

Historically, mature companies with strong cash flow and limited growth opportunities tend to give out dividends. That's because dividends are given out of profits and companies in high-growth firms require more capital for further expansion.

Bluechip companies generally pay good dividends to investors. ONGC, Tata Steel, Punjab National Bank, BHEL, Coal India, Gail (India), NTPC, Hero MotoCorp, Bajaj Auto and Bank of Baroda are the top 10 dividend yielding stocks on the Nifty-50 currently, with an yield of 3.9 per cent to 2.3 per cent.

There are several midcap and smallcap stocks that have excellent dividend yield. JB Chemicals and Pharma has a dividend yield of 51 per cent but that is because the company paid out an interim dividend of Rs 40 in August. So, investors need to look at consistency of dividends before investing in a company.

In an interesting study, domestic brokerage Motilal Oswal said dividends are a key criterion in determining the “blue chip-ness” of a stock.

According to Motilal Oswal, dividend yields are more homogenous when compared to more popular valuation metrics like price/earnings and price/book value, both across companies and for the same company over time. Dividend yield is the dividend divided by the stock price expressed as a percentage. It measures the cash flow investors are getting for each rupee invested.

High payout supports valuations and stock price levels across earnings cycles. The higher the dividend payout, the higher the P/E (the price to earnings ratio) should be, the brokerage concludes.

Some Sensex companies like Infosys, Wipro, Reliance Industries and Sterlite Industries have positive net cash or very low net debt on their balance sheets, the brokerage states. Yet they are payouts are not as high as they could potentially be. So, their P/Es are lower than high-payout peers and the high cash is deflating the return on equities, yet another dampener on valuation multiples.

Most of these stocks have lagged their peers over the last year - a strong indication that companies should start getting more generous when it comes to rewarding shareholders.

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