Stocks could be classified under two categories: growth stocks and value stocks. High dividend paying stocks usually belong to the value category. In addition, investors also expect nominal growth and capital gains on them. These expectations are on the back of positives in macro economic conditions, followed by company performance, and because of which market indices are re-rated at higher multiples during the bull phase along with the company re-ratings. The most common rationale that investors have in preferring high dividends is to get the money back from the investment made; thus, shortening the payback period of the investment.
These stocks usually provide a good option to risk-averse investors since after the quick payback period of the invested amount, the residual investment is working infinite returns. However, this rationale works for an investor who is willing to stay invested for a long time in the business. High dividend paying stocks/companies provide a safety net with the opportunity to earn tax-free returns and handsome capital gains, along with quick payback on the invested amount.
The expectation on dividend payment would also increase exponentially as the company grows in its earnings with a healthy sustainable growth rate. There are various stages of business growth; the first one is the nascent stage or the set-up stage. In this stage, the company is new into the business or has acquired a new business model and, thus, requirement of capital is very high for the setup. Hence, it builds a platform with a model and expectation of high growth and sustenance. At this stage, the business generally involves a high amount of risk.
The second stage is the growth stage where the base is built, finances are structured and the company is looking to capitalise on its base and grow exponentially. This is a short phase compared to any other stages of the cycle where still the capital requirement is high and most of the profits are retained by the company and leveraged for growth; with very low or no dividends to shareholders. These high-growth companies receive higher valuations and also carry a potential downside if the competition in the industry increases or there is a structural slowdown in economic growth, which would lower the future growth expectations and further lower its valuation multiples.
The third stage and, also the longest phase of the business cycle, is known as the consolidation phase. This is the stage