Business Today

Go for dividend stocks

Embracing the time-tested dividend-payout strategy could strengthen your portfolio’s performance.

twitter-logo Manu Kaushik        Print Edition: August 23, 2009

When Ajit Raina was building his stock portfolio, a stable income was priority for the soon-to-retire marketing professional. So, the 57-year-old Vice-President with Unitech Power Transmission decided to back his income with regular dividends.

He stocked over 70 per cent of his equity holdings with consistent dividend-paying companies—some with a high-dividend yield, other blue chips and consistent dividend payers for years like Reliance Industries, ICI (India), Novartis, Indo-Gulf Fertilisers, KEC International, and more.

“Dividend-paying companies have well-established cash flows and tend to be more stable, safer, and less volatile,” he believes. “Besides giving an additional income of Rs 50,000 per year, these stocks have appreciated well. I will keep these stocks through my retirement,” says Raina.

A dividend strategy isn’t what investors usually dig when there’s a frenzied rise in the stock markets like it happened in the heady days of the dotcom era. But if you have been an investor of dividend-paying stocks in the last three years like Raina, then there’s an increased chance that your stock would not only have fetched you a good dividend, but also significantly enhanced the value of your holdings.

A July 23, 2009 report by ICICI Securities points out that consistent dividend-paying stocks with an 8-year dividend record outperformed other stocks without a dividend record in the last three years till 2008 (see The Changing Trend). Stocks without a dividend-paying record did well in the eight out of nine years till 2005. That’s perhaps the reason why some investors still carry the mindset that stocks without dividends, usually high-growth stocks, will do well.

But after a string of weak economic news like global slowdown, poor monsoons, rising fiscal deficit and slacking foreign demand, investment experts are raising concerns about going for a pure-growth stock strategy, which includes buying companies in the nascent stage of their businesses.

On the other hand, companies with strong cash-flows and well-entrenched business models are usually those that have a good dividend track record and strong cash balances. Here’s where companies with a good dividend track record can offer pointers to stock selection. “The Indian investors have always chased exciting growth ‘stories’, with potential higher risks involved, and little consideration was given to dividends. But now, times are uncertain. Being less volatile in nature, dividend-yielding stocks give opportunity to profit from rising markets while providing downside safety,” says Sonam Udasi, VP (Research), Brics Securities.

To be sure, dividend-paying companies have also taken a hit or two in the recent downturn. Going by the latest available figures, both dividend rate as well as dividend payouts for many BSE-500 companies have either stabilised or have gone down as compared to 2007-08 (see A Steady Income). This sort of decline happens when a company wants to retain profits and ploughs them back into the business in the hope of improving performance.

However, this decline is also possible when the economy is under strain and the company’s profitability could be under pressure and it is not sure about its future cash flows. Still, market analysts believe there is little room for dividend yields going down any further from the current levels as the economy has started recovering. Besides, companies that have managed their cash flows well even in a market slowdown might be the ones to watch out for.

Investing in dividend-paying stocks is not easy and investors must watch out for a few factors like consistency of dividend, and the longterm business growth. Also, watch out for companies that are in the investment phase of their business which requires capital, and therefore, means lower payout ratios. High dividend stocks are good investments for any age group, but it holds particularly true for individuals nearing retirement age.

So, where should investors begin? Start by looking at dividend-yield stocks that provide an excellent alternative to debt instruments. Look for companies with yields hovering around the 4-6 per cent mark. For instance, buying a stock with dividend yield of 5 per cent is better than a yield of 8 per cent on taxable fixed deposits, where your taxes reduce the post-tax yield. Says Hemant Rustagi, CEO, Wiseinvest: “Dividend received is the return that the investor earns from investment in stocks. But look at capital gains, too. Over a 2-3 year period, the returns are superior to debt investments.”

Others might want to look at a dividend track record before making investment decisions. Over the years, a consistently rising dividend payout from your company will improve your yield. Say, for instance, your company’s dividend yield is currently 2 per cent, and over the next two years doubles it dividends. This increases your purchase yield to 4 per cent. So, look for companies that have the potential to increase their dividends in the coming years. Traditionally, less cyclical industries like pharma, FMCG, banking, fertilisers maintain a high and consistent dividend payouts.

On the other hand, capex-driven companies in infrastructure, construction and power sector are inconsistent in their dividend payments. Sometimes, small companies tend to lure investors with high dividends but are not able to maintain their dividend payouts over the long term. Says Hitesh Agrawal, Head (Research), Angel Broking: “Highdividend yield is an initial filter; investors should focus on the potential for capital appreciation. Analysis of future earnings prospects, regulatory controls, management quality, and sustainability of cash flow is must. Investors should not invest in companies with high debt even if dividend yields are attractive.”

In addition to this, growth of the company can give a fair idea about the sustainability of payout ratios. “Going forward, sectors such as oil & gas, petrochemicals, BFSI, auto, and pharma will find it difficult to maintain their payout ratios. At the same time, power, metals, and FMCG can be considered safe bets as payouts are expected to be favourable,” says Yogesh Radke, Head (Quant Research), Edelweiss Securities. The other factor that could be looked at is the promoter’s holding in the company. The larger the promoter’s holding, the better the dividend payout. “Since the income from dividend is free in the hands of shareholders, the promoter tries to maintain high levels of dividend payout,” says Udasi.

While it is clear that the track record of dividend payment by companies does have marginal influence on their stock-price performance, a regular dividend payout sends a positive signal to the market, suggesting that the company has the capacity to weather the downturn. But like the recent times have shown, investors are beginning to lean towards good dividend-paying companies. Such stocks provide the stability and also stand to benefit from the huge domestic growth opportunity.

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