Each time a company announces a dividend, it signals to the market that it’s doing well & that they have enough cash to not only continue/expand their operations, but also to return some money back to their investors. It’s seen as a sign of a healthy & responsible business. In fact, the stock price can sometimes gain on the back of the dividend announcement even though theoretically it should’ve decreased - this usually happens when either the market isn’t expecting any dividends or if the dividend amount ends up being higher than what the market was anticipating. Such is the power of sending a positive signal!
Theoretically, distributing dividends shouldn’t impact the overall returns as the amount paid out in as dividends is accounted for by reducing the cash balances (and hence the value) of the company, which in turn is reflected in a lower stock price. However, this usually isn’t the case in practice, and invariably stock prices don’t decline by the amount of dividend distributed. This happens because announcing and distributing dividends is seen as a very positive sign of the firm’s health by the broader market.
There are many factors that people (and in turn the broader market) consider when determining the strength of this signal. One such signal is how much the amount of the dividend has changed compared to the previous years. If it’s reduced, this is seen as a major negative signal since this usually happens when there are some underlying issues with the firm. If the dividend amount stays the same, it’s a good sign but also one that’s expected and perhaps already priced-in.
On the other hand, if the firm increases its dividend, this is taken as a very positive sign by the market - the thinking is that the company is growing & doing well enough to not only pay-out dividends but also increase it! As such, when it comes to investing to earn dividend income, identifying companies that are consistently increasing their dividends is a rewarding strategy.
Which is why we created the Dividend Aristocrats smallcase - a portfolio that consists of companies that have increased their dividends consecutively for the last 10 years. Not only does the research team identify stocks that meet this criterion like HDFC Bank, ITC, and Bajaj Finance - they also create a portfolio where every stock is weighted based on various fundamental factors, including their dividend payout. Moreover, this portfolio is rebalanced every year to ensure only companies that meet the above dividend standards remain in the smallcase.
By investing in the Dividend Aristocrats smallcase, you aren’t just investing for dividend income - you are actually investing in diverse companies that seem to be growing consistently, are operationally stable, and may send positive signals to the market.
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