Interpreting Dividend and Dividend Yield

A profit making company has two ways to utilise its profit –

• To grow or enhance the business or

• To distribute the profits amongst the shareholders

The company can also choose to give out some of the profits to the shareholders and retain the remaining for the company’s activities. The profits can either be shared in the form of money or shares of the company. The money shared with the shareholders is known as Dividend.

Many investors choose to invest into the stocks of dividend paying companies as they get tax free income in the form of dividends. One of the key metrics used by such investors to evaluate which stocks to buy is known as Dividend Yield. Dividend yield is the ratio of the annual dividend paid out by the company to the stock price.

Dividend yield measures the attractiveness of a dividend paying stock i.e., how much money you are paying for every rupee of dividend. Suppose a company pays out Rs. 10 as dividend per share and the share price of that company is Rs. 100, then the dividend yield of that company is 10%. It also means that you are paying Rs. 10 for every Rs. 1 of the dividend.

Higher The Dividend Yield, Better The Investment

A higher dividend yield is preferred over a lower or no dividend yield. A high dividend yield can also indicate the undervalued nature of the stock and there can be a possibility of the share price of this company going up in the near future. The investor can benefit from such an investment strategy in two ways, one he will get a sure dividend which is tax-free and a possible appreciation in the price of the share.
In a study conducted by Henry Chip Dickson and Charles Reinhard (Lehman Brothers Equity Research), it was observed that the high dividend yield stocks have outperformed low dividend yield stocks in the US over a 36 year period with lower risk. Additionally, another study titled “When the bear growls: bear market returns 1970-1996”, done by David Dreman and Eric Lufkin has shown that high dividend yield stocks outperformed other value strategies and the market on an average in down market quarters between 1970-1996.

Table 1 shows the performance of the top performing short term funds over a 5 year period. Returns of 1 year and less than 1 year are absolute; Returns for periods more than one year is annualized.

Table 1: Performance of Indices and Dividend Yield funds

Also one event to be noted in the graph is the drop in the indices between January 2007 and September 2008. The dividend yield category has lost the least and furthermore, the UTI Dividend Yield Fund was performing slightly lower than BSE SENSEX or the BSE 500 Index in January 2007, but has outperformed the indices in September 2008 and has continued to maintain this position since then.

Our View on Dividend Yield Funds

Dividend Yield Funds can give good returns in the long term while exhibiting lower risk in comparison to other diversified equity funds. Comparatively, Dividend Yield Funds also suffer lower losses in times of correction; this feature can definitely attract a conservative investor looking to invest into equities. Thus, we have an allocation to the UTI Dividend Yield in our conservative portfolio ever since the portfolio was incepted. Not only conservative but also, other investors can evaluate this fund category.

Our recommended fund in the dividend yield space is UTI Dividend Yield as this is the best performing dividend yield fund in the country.