The conventional appr-oach to equity investing is that companies that are doing well, are the better ones, worthy of investing. There is another emerging school of thought where loss-making companies are supposedly “investment opportunities” as these companies have a “valuation”, are burning cash to acquire a client base and are supposedly “ideas for the future”.
What will happen in the future only time will tell, but one thing is for sure, the “ideas for the future” are high-risk-high-return bets, as there is no safety net as in companies that have proven themselves, are profitable, and have a track record of paying relatively higher dividends. The latter not only pay dividends to reward shareholders, but also plough back profits into the business, to enhance earning capacity in future. The price-to-earnings (PE) ratio of these companies is lower, as the earnings per share (EPS) is relatively higher.
The dividend yield of Nifty50 companies is only 1.39%, and in Nifty500 index, it is 1.37%. This is because the dividend yield is calculated on the market price of the stock and not on the face value. To gauge the companies that are generating enough cash to pay relatively higher dividends, there is the Nifty Dividend Opportunities50 index. This index includes the top 50 companies as per dividend yield, with the filter that these are within top 300 as per free-float market cap and daily turnover. The dividend yield of Nifty Dividend Opportunities50 index is 3.65%.
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The extra cushion of higher dividends helps investors earn relatively better total returns. For a perspective on the performance, we will compare with the performance of the broad market, represented through Nifty500 total returns index. If you had invested Rs 1 lakh in Nifty500 on January 1, 2008, including the dividends, it would have become Rs 4.2 lakh on January 31, 2023. Had you invested that Rs 1 lakh in Nifty Dividend Opportunities50 index, it would have become Rs 5.74 lakh. During periods of market volatility, due to the higher resilience, high-dividend-yield stocks fare relatively better. Overall, you are relatively better off by investing in high-dividend-yield stocks.
Dividends are taxable in your hands, at your marginal slab rate. For many investors, the marginal tax rate is 30% plus surcharge and cess. Then how do you generate tax efficiency? You can go through the mutual fund route, by investing in a dividend yield fund. In mutual funds also, dividends are taxable in your hands, at your marginal slab rate. However, growth options of MF schemes are subject to capital gains tax, where the rates are relatively lower.
Systematic Withdrawal Plan (SWP) is a useful retirement planning tool, where you get a regular flow of money, as per your mandate to the AMC. As long as your SWP starts one year from the date of investment, it is subject to long term capital gains tax. Up to Rs 1 lakh of long-term capital gains per year from equity stocks and equity MFs are free from tax. Beyond Rs 1 lakh, it is taxed at 10% plus surcharge and cess. Even investors in the accumulation phase of life can avail of the SWP method and generate tax efficiency.
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Relatively higher dividends, better total returns and relatively lesser volatility suit most investors, except those who prefer the high-risk-high-return game. Generation Z investors, who are not guided by a professional advisor tend to fall for the “flavour of the times”. It could be cryptocurrency, it could be the lure of “higher-the-losses-the-better” or stock ideas peddled by unregistered social media influencers. Generation Z is one case in point; it suits any investor to have a better safety net in their investments.
On the execution of the idea, it is better to go through the mutual fund route, as there are professional fund managers and processes to be followed. Dividend yield is another filter that may be adopted, in your fund category selection. The other advantage of the mutual fund route is that you can invest in any ticket size, big or small, to suit your wallet. It also saves you the requirement of having a trading account with a broker and a demat account.
The writer is a corporate trainer and an author