Buying on dividend yield does not always pay


The trend of lower dividend payouts means that investors may not be able to count on steady cash-flow from dividends while the economy is in this growth phase.



Shanthi Venkataraman

In a volatile market such as now, should you invest in a stock for the dividend it pays? Conventional wisdom suggests you should. In a market downtrend, buying stocks of companies with a high dividend yield is considered a good defensive strategy.

Dividend yield, which is dividend per share as a percentage of the market price, is a classic "value" measure that allows you to zoom in on stocks that are only temporarily out of favour, or perhaps under-priced.

The dividend yield strategy has, however, not paid off very well in the last couple of years in the Indian market, except for brief phases. Growth (high PE) stocks have outperformed 'value' stocks globally. Besides, the universe of stocks offering a good dividend yield in India has also shrunk considerably.

Declining yields

For those on the look-out for high dividend yields in the present market, it might be slim pickings. The Nifty index currently trades at an abysmally low dividend yield of 0.97 per cent. Some Asian markets, such as Singapore, Taiwan and Thailand, still enjoy yields of 3 per cent and more. India has not, in any case, been a traditionally high dividend yield market.

The Nifty yield was at 3 per cent in April 2003, at the beginning of this bull rally and has been on the decline ever since. A similar trend can be witnessed in the Nifty Junior and CNX Midcap indices. In a market where money continues to chase stocks that deliver high growth, a dividend yield of at least 3 per cent may be necessary to attract value buyers.

However, among the stocks that constitute the BSE-500 Index, less than 10 per cent enjoy a dividend yield of more than 3 per cent. The declining trend in yields is only to be expected in a bull market. The Nifty's low dividend yield may be yet another example of how difficult it is to find 'value' in the Indian markets today.

Less bang for the buck

However, it is not just the rally in stock prices that has led to a decline in yields. The fact is, companies are now paying out a lesser proportion of their profits as dividend, compared with even three years ago.

In absolute terms, dividends declared by India Inc have been on the increase.

The total dividend paid by companies in the BSE-500 was over Rs 45,000 crore in 2006-07, against Rs 35,000 crore in 2004-05. The number of companies in this basket that declared a dividend also increased during this period.

But the average dividend payout ratio (dividend as a proportion of profit after tax) of companies in the BSE-500 declined from 25 per cent in FY-05 to 18 per cent in FY-07. Nearly half the stocks have seen a decline in dividend payout ratio.

This is not necessarily a bad trend. In a growing economy, companies are naturally expected to retain and re-invest more of their profits to expand their business. The trend does, however, mean that investors should not probably count on steady cash-flow from dividends while the economy is in this growth phase.

Dividend Yield funds underperform


Considering the homework involved in following the dividend yield approach to investing — keeping track of yields, knowing which stocks to buy and exiting them at the right time — you might feel that the theme is best played through the mutual fund route. However, dividend yield funds have hugely underperformed the market in the last three years.

They have not been particularly good at containing downside either, going by the performance in the recent stock market correction.

While the theme itself has not worked in the last three years, funds focused on yields, are also forced to filter down the holdings to more liquid stocks.

But many good dividend yield candidates tend to be relatively illiquid.

Some funds have had to lower the bar on yield requirements in recent times in order to boost performance.

But considering that the number of ideas is shrinking, the fund route may not be the best way to capitalise on this theme.

HOW TO PLAY THE THEME

Does the trend of rallying prices, declining dividend payouts and poor performance by funds that ride this theme mean that the dividend yield concept is a write-off in the market today? Not necessarily. But you may have to play the theme selectively.

There are still some good dividend yield (over 3 per cent) stocks out there, that have, more or less, maintained or increased their payouts over the last three years. Andhra Bank, Ashok Leyland, Graphite India, ONGC and Tamil Nadu Newsprint. HCL Infosystems, SRF and Wyeth are stocks that have a high yield currently but have been re-investing a greater proportion of their profits in recent years. To make money from dividend yield stocks, however, you need to get your timing right.

Generally, the dividend yield strategy outperforms when the market recovers from the bottom.

In sudden sharp corrections, you may be able to pick up a stock that has a high dividend yield and gain once the market recovers. But timing the bottom of a correction is not easy. And returns might taper off once the recovery is over. So such stocks may call for an active profit-booking strategy.

Some dividend yield stocks also work as good defensives; that is, they can contain downside when liquidity is tight or when the market appears to be at its high. Again, you need to select the right kind of stocks.

Some high dividend yield stocks may be out of favour with the market and may plunge further in a downward correction. In panic sell-offs, such as the one seen recently, investors do not appear to set great store by a company's dividend yield.

Stocks with a high dividend yield can still be buys, but only if they appear attractive on business prospects as well. But it's not time to bid goodbye to the concept just yet.

The Dogs of the Dow, a strategy that involved putting equal sums of money in the top ten stocks of the Dow Jones Index by dividend yield, paid off handsomely for several years. Value investors may simply have to wait their turn.