Dividend stocks are income and growth-oriented and hence are popular among investors looking for regular income and long-term capital capital gains. For a profitable dividend portfolio, it is essential to consider the quality and the sustainability of the dividend income.
In this blog, we will explore the 5 important parameters investors can use to gauge the potential of dividend stocks.
Dividend Yield
The annual dividend paid by a company expressed as a percentage of its current stock price in the stock market is known as its dividend yield.
The dividend yield on a company with an annual dividend of ₹10 and a market price of ₹200 is 5% (₹10 / ₹200).
Dividend yield shows the return on investment from dividends alone. It’s a crucial indicator for income-focused investors. A high yield implies better income prospects for shareholders.
However, if the yield for a particular company is much higher than for its peers it can indicate that the stock price has fallen significantly due to underlying issues.
Dividend Payout Ratio
The percentage of earnings given to shareholders as dividends is shown by the dividend payout ratio. It is computed by dividing the annual dividend per share by the earnings per share (EPS).
For example, if a company records an EPS of ₹25 and distributes a dividend of ₹12. 5 per share, the payout ratio is 50% (₹12. 5 / ₹25).
A reasonable payout ratio indicates that the company is paying out a fair amount of earnings while also retaining enough cash to fund its operations and investments in growth.
Dividend Growth Rate
The dividend growth rate refers to the rate of growth per year of the dividend over a specified period, usually five to ten years.
A positive dividend growth rate indicates the company’s ability to enhance shareholder returns over time, reflecting financial strength and stability.
It is also important to assess the general economic conditions and sector-specific trends in which the company operates for potential threats to dividend growth.
Free Cash Flow (FCF)
Free cash flow is the amount of cash flow that a company can generate from its operations independent of its expenditure on fixed assets.
If a company has an operating cash flow of ₹500 crore and the company has invested ₹200 crore in capital expenditures then the free cash flow is ₹300 crore.
It’s a very significant indicator in determining if the company has adequate cash to purchase new equipment and pay off debts. Positive and growing free cash flow is a good indicator of a company’s ability to sustain and potentially increase dividend payments.
It provides insight into the company’s financial flexibility.
Debt-to-Equity Ratio
The debt-to-equity ratio measures a company’s financial strength by comparing its total debt to its shareholders’ equity.
If a company has total debt of ₹300 crore and shareholders’ equity of ₹600 crore, its debt-to-equity ratio is 0.5 (₹300 crore / ₹600 crore).
This helps the investors to understand the capital structure of the company and its financial strength. A lower debt-to-equity ratio suggests a more conservative financial strategy with lower risk, while a higher ratio might indicate increased risk due to high leverage.
The Bottom Line
Evaluating dividend stocks in India involves analyzing several key metrics to ensure that your investments will provide a reliable and sustainable income. Investors can use the five key metrics—dividend yield, dividend payout ratio, dividend growth rate, free cash flow, and debt-to-equity ratio to gain valuable insights into a company’s ability to maintain and grow its dividends.
By carefully examining these metrics, investors can make more informed decisions, aligning their investment choices with their financial goals and risk tolerance.
