InvestorQ : Can I buy stocks with high dividend yields since I find that there are some stocks that pay close to 10% dividend yield? Is that a good approach?
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Can I buy stocks with high dividend yields since I find that there are some stocks that pay close to 10% dividend yield? Is that a good approach?

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Nisha Chandani answered.
3 years ago
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This is a slightly more conservative approach to investing. Normally, investors tend to invest in bonds in search of stable returns. An alternate could be to invest in high-dividend yield stocks. Classic examples are stocks like Coal India and Indian Oil which have dividend yields in excess of 8%. The reason dividend yield approach works is that dividends are tax-free in the hands of the recipient up to a limit of Rs.1 million per annum (even this was introduced only in the 2016 budget). A 7% dividend yield, therefore, becomes equivalent to 10% return on bonds. This is what makes the dividend yield approach to stocks quite useful for conservative investors. There are some investors who also use the earnings yield approach (inverse of P/E ratio) as a proxy for income earning capacity; but that is not very popular.

However, there are two words of caution here. Firstly, stocks that pay high dividends don’t get good valuations in the market and hence you will normally find them quoting at low P/E. That is because dividend payout is seen as a signal of limited investment opportunities for the stock. Secondly, dividend yields may not sustain. For example, dividend yields may look attractive in oil companies because prices have fallen. However, if the profits turn into losses due to a rise in crude prices then the dividend yield assumption may not really work.

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