Low-yield stocks could get you higher returns

MUMBAI: In a volatile market such as one we are in right now, are investors better off betting on high-dividend yield stocks? After all, buying such stocks is traditionally considered a good defensive strategy in turbulent market conditions.

But there is a school of thought that propounds the view that investors tend to overlook capital appreciation, for which equities as an asset class are known for. In other words, the primary objective of equity investments is capital gains, rather than fixed returns. If one was to keep this aspect in mind, low-yield stocks, by virtue of belonging to moderate-to-high growth sectors, could actually have a higher likelihood of giving better returns.

"Remarkably, low-yield stocks reported a higher average eearnings growth Y-o-Y (65% in FY07 and 37.5% in FY08) vis-à-vis high-yield stocks (30.5% in FY07 and 14.9% in FY08)," says Keynote Research senior vice-president Nitin Khandkar.

Dividend yield is the annual dividend paid by a stock, divided by the current stock price, expressed in percentage terms. The goal is to give investors an idea of the cash return they can expect from the money they've put at risk. Typically, in a bear market, a large number of investors seek out high-dividend yield stocks, spurred by the belief that the latter provide returns similar to that of fixed deposits with banks.

"But if profit growth in high-yield stocks is indeed lagging that in low-yield stocks, can the former really be considered a safe bet. We believe slower profit growth may indicate a lower probability of dividend percentage and payout being maintained, going forward, failing which the yield could decline, making these stocks 'less attractive' than they appear currently," adds Mr Khandkar.

It's fair to say the dividend yield is one indicator of how risky a stock is. But, it's just one measure and not 100% certain, say analysts. For companies can start or stop paying a dividend at any time. It's important not to take false security from the fact that a company pays a dividend.

According to Jay Prakash Sinha, head-institutional equities at Mangal Keshav Securities, it ultimately boils down to the risk appetite of an investor. "If you invest in low-yield stocks you are clearly looking for better capital appreciation." Low-yield stocks that could actually have a higher likelihood of giving better returns, by virtue of belonging to moderate-to-high growth sectors.

The most popular explanation of a company stock with a low-dividend yield, say 1% or less, is that the company is still in rampant growth mode. Aggressive capex plans, etc, may see the company plough back cash into the company rather than give it to shareholders in the form of a dividend. Does that make the stock riskier, not necessarily, say analysts. A pertinent and oft-repeated example is that of Warren Buffett's Berkshire Hathaway. The company doesn't pay a dividend, is a large enterprise and famous for its careful growth strategy (the who's who of the Indian equities market attend the company's AGM). Reportedly, Berkshire is sitting on $45 billion in cash.