India is an emerging market, i.e. it is quickly expanding with most Indian companies retaining money to boost their development. And this, leaving low stock dividends.
Companies pay high dividends for a few motives.
Either they see no better way to deploy surplus cash or they want to placate their shareholders or promoters, as in the case of PSUs. Investors may fall into a dividend trap when the payout is unsustainable and even a tiny profit loss results in dividend reductions.
Often considered as safer than low-pay-out companies, dividend stocks include all equity investment risks without offering protection of fixed-income bonds.
Between the two, high-dividend stocks, the investor is exposed to a potential loss in underlying stock prices, while at the same time giving an uncertain and lower return than in fixed income. Solving neither the purpose of capital appreciation nor the value of the return on capital.
With the high-yield investment, the stock universe of the investor can purchase shrinks significantly, increasing the concentration of investments into a few stocks. Portfolio concentration leads to exposing big parts of the investor’s assets to black swan incidents. This danger offsets the gains through passively investing in these stocks. Mistaking heavy dividend-paying stocks for bonds is a bad decision, investors are too late to learn after earnings, and their dividends paid collapse.
If not all was too bad, the government also has a system of triple taxation on dividends. First, at the level of corporate income tax, then at the level of dividend distribution, and finally again as income tax in the hands of the investor. Making dividends tax-efficient.
Dividends are not extremely volatile in nature, but that does not imply that their underlying shares are predictable. People imagine that high-yield shares would not oscillate with economies, using the last year’s return on some high-dividend stocks, we can see that they are not the reliable havens they are expected to be.
Focusing on dividend return rather than total return, and the investor is fated to underperform the market and the dividend returns barely compensate for this.
Investors working on a much-vaunted income-based strategy may instead have their hands filled with pyrite.
Ghanisht Nagpal is a professional investor and founder of equibot.in – a stock market tool suite. He is the convener of the Delhi Investors Association.
Cover Image Source: McGill University