Dividend yield (in percentage) is the ratio of total dividend declared per share for the previous accounting year (D) divided by the current market price at the time of investment (P) i.e. D/P * 100. High dividend yield scripts are those companies that pay-out higher dividend as they are able to generate cash from their business.
In Dividend Yield funds, the fund managers predominantly invest in equities that are expected to continue sustaining high dividend payouts in future. Dividend yield is considered high if it is greater than the dividend yield of the Nifty (available in the NSE website). These scripts also provide an opportunity for capital appreciation by unlocking the potential growth of the price due to under-pricing in spite of its cash generation.
Even though, high dividend yield is a prime factor, they also consider parameters such as business fundamentals, management competence, growth prospects, industry scenario etc.
Risk involved
We looked at the performance of six dividend yield funds that have been in existence for over 5 years and found that at least 5 out of these 6 funds have outperformed the benchmark indices over time frames of 5-year, 3-year and 1-year.
Further, our analysis shows that these funds are mainly expected to safeguard wealth in a falling or bearish market but generally do not generate huge returns in a mid- and small-cap rally. Also, high dividend stocks at times are less liquid as compared to growth stocks. Moreover, the performance of this fund category purely depends on the stock’s ability to sustain dividends in future.
Who should invest?
Dividend yield funds are ideal for those clients who:
- Are risk averse;
- Wish to create safe income over a long term by investing in stocks that are less volatile than the growth-oriented stocks.
Factors that need to be measured before recommending dividend yield funds
- Should have outperformed their respective benchmark index consistently across various market cycles
- Expense ratio (lower the better)
- Portfolio should be high on quality and liquidity