Profit from dividends

When stock prices fall, the dividend-yielding scrips offer a cushion to investors. But do these options make for a good buy when the prices go up?

A safe stock sounds paradoxical, especially in the current volatility. However, for the past one year, investors have found a cushion of safety in some stocks. Not in multibaggers, nor in selling at dramatically high prices, but in stocks that offer a steady dividend yield. These are largely stocks of pharma and FMCG companies, even some information technology firms, a few of which proved resilient to the downturn and rewarded shareholders.

An analysis of the 229 companies (listed on the BSE 500), which declared their results for fiscal 2009, shows that more than 60% maintained their rates of dividend compared with last year, while 20%, including those in FMCG and pharma sectors, increased them. “Many companies in these two sectors have been relatively less impacted by the global turmoil, due to which their core financial performance has not been affected to a great extent,” says Hitesh Agrawal, head of research, Angel Broking. Hence, the higher payouts to the shareholders.

Take FMCG. Nestle increased its dividend rate from 330% last year to 425% in 2008-9 due to a 23% growth in profit. The stock has maintained a consistent dividend yield of 2.5-3% for the past few years. Companies such as ITC, Colgate-Palmolive and Marico also witnessed a sharp expansion in margins of 5.9%, 4.5% and 3.3%, respectively. Three consecutive years of good monsoon, a rising standard of living and surge in demand from rural India augurs well for this sector.

Agrawal opines that some firms in the pharma sector too are poised to benefit from global opportunities in the contract research and manufacturing services and the generics space.

In the IT arena, dividend payout has been more varied. Among the biggies, Wipro reduced its dividend for 2008-9 to Rs 4 per share (from Rs 6 in 2007-8), TCS kept it constant at Rs 14, while Infosys actually hiked its dividend to Rs 23.50 per share (from Rs 13.25).

The banking sector is also attractive, although a sharp rise in the price of some banks like the Union Bank of India may not be attractive from the dividend point of view. Then there’s Crisil, which has increased its dividend rate from 100% in 2005 to 700% in 2009 on the back of a steady rise in profits.

Will this trend continue? “Traditionally, the Indian management has been reluctant to cut dividend as it sends out a wrong signal to investors,” says Amitabh Chakraborty, president, equity, Religare Capital Markets. Many companies do not alter their payout ratio on account of cyclicality or a short-term pressure on business, adds Agrawal. Given that these companies are fairly cash-rich, shareholders can expect continued dividend income.

The dividend yield strategy works well when stock prices are low. However, the sharp increase in prices over the past three months has reduced the yield. Take Hindustan Unilever (HUL). The dividend yield for the stock was close to 4.5% in October 2008, when it was at around Rs 220. With the price moving up to Rs 260, the yield has fallen to 3.4%.

Is it still a good strategy to buy dividend-yielding stocks? While these offer some respite during uncertain times, they are better suited to investors with a lower risk appetite, says Agrawal. So, although HUL is a good fit in any portfolio due to its strong fundamentals and pedigree, at Rs 260, Agrawal feels the stock has already priced in its upside. It may be more advisable to buy cyclicals or stocks with high growth and high beta, says Chakraborty. Tata Steel, India Infoline and Tata Motors have declared good dividend per share and also offer high growth as the market moves up, he adds.

The trick is to choose a company that offers sustained performance and reasonable valuations, so you do not lose a greater amount of capital through stock value depreciation than that earned through dividends. With the economy showing signs of revival, several companies are likely to use cash for capex or profitable ventures, so they may not pay such high dividends, says Chakraborty. If you are willing to take some risk, look for a blend of capital appreciation and dividends.