Stock dividends: Why yield, inflation and taxation are important factors

view original post

As companies finalize and declare the results for the March quarter and, indeed, the financial year 2023-24, one aspect that investors keenly look forward to is the announcement of dividends while firms announce their financials.

To be sure, some companies keep announcing dividends across all quarters. But many tend to announce one at the end of the financial year.

Although a relatively small population, many savvy retail investors have stayed with stocks for decades and now manage their entire or a good portion of regular expenses with dividend payouts alone. A few may even have covered their cost price of shares with dividends alone.

We are not making a case for investing in dividend-yielding stocks here. Instead, the idea is to understand the key aspects of dividends to make them work better for you. So, dividend yield, how regular flows can be managed for those looking to live off dividends, the key aspect of payouts having to catch up with inflation for them to be meaningful, and finally, the taxation angle, all become important factors to consider.

Contextualizing yield

Simply put, a stock’s dividend yield is the dividend paid by the company divided by its stock price. In the Indian context,, a 1-2 per cent dividend yield or more is considered reasonably healthy.

Therefore, for you as an investor to earn a sufficiently large amount as a dividend, the amount invested must also be high enough.

For example, a 1.5 per cent dividend yield on a portfolio of ₹1 crore would give ₹1.5 lakh annually. You must determine by your own financial planning methods if this amount is enough for your expenses if you plan to live off dividends alone. Else, you will need to have other sources of regular income generation.

So, while dividend yields may look good, their significance comes from a sufficiently large corpus size.

The second aspect about dividends is that some may not even be paid at times if a company’s cash flows are strained, or if a large capex plan that is internally funded is planned, or there is a regulatory condition on declaring dividends. For example, the RBI rules disallow banks from declaring dividends if their non-performing assets cross a certain threshold.

Then, there may be uneven dividends – high in some years, low in a few others – which may happen with cyclical companies. For example, JSW Steel declared ₹6.5 as dividend for FY21, ₹17.35 in FY22 and ₹3.4 in FY23. Planning for lower sums is another challenge for investors.

Then, there is the case of cashflow management. If some companies in your portfolio declare dividends every quarter and others annually, the timelines when the amounts hit your account would vary, causing a cash flow problem. One possible way to deal with this mismatch is to start using dividends at the end of a financial period while having alternate sources of income in the interim.

So, an investor can wait for one financial or calendar year to let all dividends accumulate and spend them from the second year onwards. This way, you will know precisely how much you have at your disposal.

Keeping inflation at bay

As with every source of income, even dividends must grow over time and beat inflation rates – more so for those heavily dependent on such payouts.

Thus, we get to dividend growth investing. In this strategy, company dividend payouts must grow at a pace that exceeds the prevailing inflation rate.

If dividends grow at a healthy pace, any increase in lifestyle costs can be met comfortably.

Tata Consumer Products increased its dividend from ₹4.05 in FY21 to ₹6.05 in FY22 to ₹8.45 in FY23. LTI Mindtree offered ₹45 in FY22, ₹60 in FY23 and ₹65 in FY24. In both cases, the growth rate in dividend payouts easily beat the inflation rate.

None of the above stocks are recommendations to buy, hold, or sell; they are given merely to illustrate the dividend payouts.

Dividend growth is crucial because even a low dividend yield stock that steadily increases its payout due to rapid business growth will eventually become a good dividend-yielding stock as the firm reaches maturity.

Dealing with taxes

Before April 2020, dividends were tax-free for investors who received them. However, they have become taxable subsequently.

In fact, dividends received are added to your regular income and taxed at the marginal slab applicable to you. If the dividend is more than ₹5,000 per company per year, tax is deducted at source at 10 per cent, and the balance amount is credited to you.

Form 15G/15 H can be submitted in case your dividend needs to be taxed at a lower slab or not, as your overall income, including dividends, falls below that rate.