Dividends matter! How they help you become rich - Explained

'Dividends are an investor's best friend', John Bogle, the founder of the Vanguard Group, said. The importance of dividends can be gauged from the fact that, unlike earnings, dividends can't be manipulated or faked.

Investing in stocks that pay dividends is considered to be a strategic way to make a reliable and good source of regular income to build wealth. Besides, it also preserves the purchasing power of capital, especially at a time when inflation is running above 6-7%. 

Understanding dividends 

When an individual buys stocks, he/she generates returns from two sources – capital appreciation and dividends.

Dividends are basically the share of profits that a company distributes to its shareholders. It has been observed historically that of the total returns generated from stock investing, one-fourth have come via dividends, according to Siddharth Oberoi, founder, Prudent Equity. Hence, dividends are an important component of total returns. 

He said that the list of dividend-paying companies is pretty large. About 75% of stocks in the BSE S&P 500 pay a dividend. As of March 2022, 90% of the Nifty 50 companies paid dividends.

A dividend can also serve as a barometer of a company's health. Companies that pay dividends make the dividend an important part of their capital allocation strategy. One primary benefit of investing in dividend-paying stocks is that well-established companies increase their payouts after regular intervals.

Consider dividend-paying stocks

Investors often consider investing in dividend-paying companies to be more lucrative as they get a share of the company's profits every year in the form of dividends.

"There is hard evidence that shows that in recent years, companies that paid dividends have outperformed non-payers. As a group, companies that have increased their dividends have outperformed the other dividend payers by a wide margin," Siddharth said.

"At a time when a fixed deposit earns a mere 5-6% return, high dividend-yielding stocks provide a dual advantage – that of recurring returns via dividends as well as the potential for capital appreciation. Thus, tilting the favour for those companies that pay and increase dividends every year," he added.

Capital protection

A rising dividend payout gives confidence to the shareholders that the earnings are real. Dividends also help in capital protection. If a high dividend-paying stock moves southward, its dividend yield makes it so attractive that investing just for dividends makes up for the risk.

Siddharth said that companies that pay sustainable and growing dividends are more resilient in down markets. "Investors in dividend stocks aggressively buy in downturns due to an attractive yield."

In today’s time when people are reeling under high inflationary pressures, returns from dividends can be vital in protecting the purchasing power and can also act as a hedge against inflation.