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Stocks with lifebuoys

Stocks with high dividend yields tend to be less volatile. But there are other things to look out for before you invest in such shares.

Tanvi Varma/Money Today        Print Edition: November 27, 2008

A safe stock may seem like an oxymoron in today’s market. However, carefully researched stocks prove to be relatively safe bets in a frenzied market. Our research shows that in turbulent times, stocks with high dividend yields tend to be less volatile.

The dividend yield of a stock is the dividend as a percentage of the stock price. So if Bongaigaon Refineries is trading at Rs 36 and the company paid a dividend of Rs 5 last year, the dividend yield of the stock works out to 14%. If the stock price drops to Rs 30, the dividend yield would move up to 16.7%.

The Indian stock market has invariably been growth-oriented and dividend income from stocks has seldom been a consideration. Why would an investor have cared for a dividend income of 5-10% when stock prices were doubling, even trebling, in five-six months? Growth stocks were the flavour of the market during the bull run, but they were also the biggest losers when the bears took over.

The volatility and uncertainty has once again shifted the spotlight to the safety and security of dividend income. Consider this: diversified equity funds that focused on dividend yield stocks have lost the least in the past one year. While the diversified equity funds, as a category, have lost 50%, dividend yield funds, on an average, have lost only 35%. Their investment mandate keeps dividend yield funds away from growth and momentum stocks that are characterised by high PE ratios and galloping stock prices. “Dividend yield funds aim to invest in stocks that offer a dividend yield higher than that of the Nifty. At the same time, they ensure that these stocks have a robust business model, consistency of earnings and offer capital appreciation,” says Manish Bhandari, vice-president, ING Investment Management.

When most other diversified funds were buying capital goods and realty stocks, the UTI Dividend Yield Fund was concentrating on the PSU banks, FMCG and pharma sectors. These sectors have not been directly affected by the global financial crisis. The fund remained underweight in construction and realty. The result: UTI Dividend Yield Fund has lost only 47% compared with the 53% fall in the Nifty in the past 10 months. “At least 65% of the stocks in the fund’s portfolio have a dividend yield higher than the Nifty average,” says Swati Kulkarni, fund manager, UTI Mutual Fund.

Of course, a high dividend yield by itself does not make a stock attractive. What if the dividend dips because of a drop in the company’s earnings? That’s possible, given the impending slowdown. There are nearly 50 stocks in the BSE 500 with a dividend yield of over 6%, but many of them belong to cyclical sectors which may be affected. “Sectors such as real estate, construction and metals may be impacted due to the economic slowdown,” says Hitesh Agrawal, head of research, Angel Broking. Therefore, he advises investors not to get carried away by high dividend yields. “It may be better to buy stocks that have a consistent but average dividend payout, with the scope of capital appreciation,” he says. The fundamentals of a company are more important than the yield they are quoting.

The oil and gas sector looks particularly vulnerable due to the 50% drop in crude oil prices in the past four months. The cement sector too is 1plagued with oversupply and a price cut is on the cards, which could lead to depressed profits. “Some companies, especially in cyclical industries, might cut dividends due to reduced earnings and scarcity of capital,” says Amar Ambani, vice-president, research, India Infoline.

That’s why fund managers and investment advisers put dividend stocks through several filters before deciding which ones to buy. The key is to pick companies with a good dividend payment record and sound managment in slowdown-proof sectors. We have drawn up a list of 10 such stocks based on the recommendations of brokerages and holdings of mutual funds. Sure, these stocks won’t give extraordinary returns when the markets look up. But what they offer is something more precious: a reasonable level of safety in uncertain times.

TOP DIVIDEND STOCK PICKS
StockCurrent
price (Rs)
PE
Dividend
yield (%)
% price
change since
1 Jan 2008
Sector
Chennai Petro120.751.514.1 -72Oil & Gas
Wockhardt109.908.910.2-74Pharmaceuticals
GE Shipping217.402.56.9-60Shipping
Gujarat Ind Power Co41.957.06.0-69Power
HCL Tech172.5015.0
5.2-47Computers
Alembic30.107.55.0-69Pharmaceuticals
ONGC669.807.84.8-46Oil & Gas
Castrol India293.3013.34.8-16Oil & Gas
GAIL213.458.34.7-61Oil & Gas
Hindustan Unilever222.0025.44.12FMCG
Stock prices as on 31 Oct 2008

 

HOW TO CHOOSE A DIVIDEND STOCK
Consider the following four parameters:

Dividend record: Choose stocks with a consistent payout track record over the past 3-5 years to avoid the impact of any extraordinary financial events.

Sustainable cash flows: To pay consistent dividends, the company must have a sustainable cash flow. This is crucial in view of the anticipated slowdown.

Management quality: The credibility of the management plays an important role in the running of a business. Choose companies with a solid background.

Debt liability: Avoid companies that have a large debt on their books. Too much debt could reduce the dividend as earnings may go into paying the interest.

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