Here are the pros and cons of investing in dividend-paying stocks

The majority of the annual profits realised by these companies are disbursed annually among investors, which helps them to establish goodwill in the market. A small amount may be retained for reinvestment in the business to fund expansion projects in the future.

Such timely distribution of profits can be accredited to the robust financial foundation of large-cap companies, which are sufficient to withstand any economic turmoil causing unpredictable stock market fluctuations.

Production levels of large-cap businesses are not affected drastically even if stock market fluctuations demonstrate a downward trend, ensuring stable profit generation. On the other hand, investors believe that the company will be able to withstand such turmoil owing to its robust financial backing, as revealed by relatively stable stock prices. Now that we know what kind of companies pay dividends, let’s see the obvious advantages of investing in such stocks.

Annual dividend poses as a stable source of income for individuals, which you can either utilise to fulfil any personal needs, or use it for reinvesting in the stock market. Such returns come in addition to the preservation of the corpus amount, ensuring high yields for investors.

As stated above, dividend stocks are usually issued by large scale companies operating in an economy. Such companies already possess a strong market presence, thereby mitigating the risk factor to some extent. Unfavourable market fluctuations don’t affect the productive capacity of such companies significantly, owing to a substantial retained earnings base.

Dividend reinvestment plans allow shareholders to convert their cash dividends to earn a higher equity stake in a company through stock dividends. Such additional stocks are often given at discounted rates by stipulated companies, thereby distributing a higher number of shares per investor. Also, no commission has to be paid while procuring such stocks, increasing the total yield.

An increased stake in companies that distribute regular dividends can lead to a hiked yield in the future, thereby increasing their profitability in the long run.

While there are advantages to choosing dividend stocks, there are a few limitations of these stocks as well. Let’s take a look.

Capital gains: Dividend stocks do not lead to capital gains for investors, as the unit stock values of such large-cap companies do not demonstrate fluctuations of high degree with variations in the stock market. Thus, such shares are not suitable for short-term investment goals, as price variations between such timespan are nominal.

Expensive: Shares associated with routine dividend pay-outs are mostly issued by large-cap companies such as industry giant businesses and multinational corporations. Securities issued, consequently, are of substantial value. Also, since most people tend to hold on to such shares after acquiring them, finding a seller in the market may prove to be challenging.

Not assured: Dividend pay-outs are not mandatory, and are announced by the company when it generates substantial profits for any given year. Nonetheless, the management can decide upon not distributing accrued gains among shareholders in this respect to increase the retained earnings base for business development and expansion purposes.

Tax: Before a company distributes total profits earned in one financial year in the form of dividends, a dividend distribution tax at 15 percent has to be paid. Such a tax burden reduces the aggregate amount to be disbursed among shareholders, thereby reducing the respective earnings of each investor.

Also, income tax has to be paid by shareholders if their total dividend earnings exceed Rs 10 lakh in one financial year. Income in excess of Rs 10 lakh is taxed at 10 percent, as per the Finance Act of 2017.

Limited growth opportunities: Large-cap companies are primarily responsible for issuing dividend stocks, as they have the resources to undertake large scale production and distribute corresponding earnings among shareholders, without retaining a substantial portion for reinvestment. However, widespread growth opportunities are limited for such companies, owing to their substantial market presence. As a result, the dividend payable is likely to be steady during extended periods, subject to minor changes through further expansion.

Equity shares distributing substantial dividends periodically are ideal for investors looking for long term investment options, wherein the security of corpus is crucial. Novice investors looking for alternatives to earn higher returns through the stock market can choose to include such shares in their portfolio.

Additionally, experienced investors looking to dilute the risks involved can allocate a portion of their total investment portfolio to purchase such shares. This helps them enjoy a steady income through routine dividend pay-outs even during times of distress in the stock market causing losses through other riskier investments.

Thus, if you have just started investing in the stock market, and are looking for reliable investment options, or want to mitigate risks associated with such investments in the share market, opting for dividend stocks is an attractive option. Nonetheless, as such investments have to be kept locked in for an extensive period to realise adequate profits, make sure the proportion of money you invest in dividend stocks suits these criteria, and hence, is not required for fulfilling any short-term requirements. Going through the financial statements of companies and history regarding dividend payments and corresponding market reputation will help you identify such businesses with ease.