Things to know for buying a dividend stock

May 13, 2013

In this issue:
» Green shoots in economy
» Does RBI need to penalise these banks?
» Long term return from realty is zero
» Bernanke concedes to risks because of QE
» and more....

Investing in stocks that pay healthy dividends is a good idea. After all dividend forms an important component of total returns. In fact to a large extent it is the predictable component of total returns. The question is should you invest in all dividend paying stocks? Or are there some points that you need to keep in mind when it comes to selecting the best stocks? Like all other stocks, the answer is obviously the second one. An interview in the Daily Crux helps to narrow in on four questions that investors need to ask before investing in a dividend stock.

The first question is how the company earns its revenues. Are its revenues stable or are they highly cyclical. For this it is necessary to understand whether the business of the company is stable or is it risky, cyclical, based on too much debt, etc. The former is the better business. Because if the company's own income is dicey, then its dividend stream will eventually follow suit. The second question to ask yourself is how does the company manage to keep its cash flows stable and growing? In other words the question is what is the competitive advantage that the company enjoys that it will not only be able to keep its cash flows stable but also be able to grow them. The competitive advantage helps the company build a safety moat around itself. This moat would protect the business from competition. And if the company is able to use its competitive advantage to widen the moat over time, then it is the perfect business to be in.

The third question is whether the company is able to grow its earnings or not. If it has stable cash flows and is able to grow them, then it should ideally follow that earnings are growing too. But if the company is growing its cash flows and not its earnings, then it is possible that it is manipulating its cash flows. This could be risky. If earnings don't grow, then it will follow that dividends will not grow. The final question is the risks associated with the company itself. For this you need to question things like competition, is the management proactive; management's capital allocation skills, etc.

To this question set we feel one more very important question needs to be added. And that is whether the stock is available at cheap valuations or not. For if you pay too high a price for a good dividend stock, then in the long term your returns would be miniscule if not negative. Only when you buy a good stock at cheap valuations are you able to maximize your long term wealth. Investors would do well to use this checklist next time they want to buy stocks purely for dividends.

What are the points you keep in mind before investing in dividend stocks? Please share your comments or post them on our Facebook page / Google+ page

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 Chart of the day
India's exports have slowed down in recent times. The gloomy global environment is a big reason for this. And obviously the cure for that is not in the hands for our government. But there are certain steps that the government could take to try and boost the growth in exports. One such step is to increase investments in Special Economic Zones or SEs. As seen in the chart, there appears to be a correlation between the investment in SEZs and the value of exports. For boosting investment the government could invite private participation as well. However for this it needs to make sure that there are clear cut policies available. In addition to making investments easy there is also the need to make investments lucrative. For if the investors are unable to earn lucrative returns then they would not be interested in investing at all.

Souce: Financial Express

Recent moderation in crude and commodity prices offered India Inc. some reasons to cheer. Finance Minister Chidambaram has also stressed on unclogging stalled infra projects. Corporates and bankers are relying on new reform measures in the hope that they will kick start economic recovery. The encouraging industrial production number (IIP) is being claimed by many as 'green shoots' in the economy. But a realistic look at macro economic statistics can tell us that it is way too early to cheer. The Reserve Bank of India (RBI) governor has in no uncertain terms cited that the ballooning current account deficit (CAD) remains a key risk. Interest rate cuts too will come in only once the deficit concerns are reasonably taken care of. Thus the 'feel good factor' may temporarily boost stock markets. But it is best not to speculate on near term economic prospects. Long term investors would do well to not read too much into statistics speculating on near term economic scenario.

In a country like India where property prices continue to remain high, one would assume that this asset class represents the best investment in terms of returns generated. But an article in the Economic Times disputes this claim. Taking the case of commercial property in Nariman Point, Mumbai. Those who invested in the area in 1994 actually witnessed a fall in value of their investment 20 years later to the tune of around 9%. In the same period, NSE-Nifty delivered an average annual return of 1% adjusted for inflation. Of course, this is just one example and real estate in other parts of the country may not necessary display the same trends. But the idea is to dispel the notion that investment in real estate will always assure high returns. One of the reasons for the same is increase in supply. There is no dearth of land in India. So when real estate prices skyrocket, it triggers a fresh boom of construction. And because of this new supply, the impact of the boom tapers off. Globally too we have seen the housing sector meltdown in the US and the folly in believing that house prices were never going to crash. So investments in real estate have to be made by understanding the inherent risks and keeping expectations reasonable.

The Cobrapost expose on the money laundering practices in Indian banks is just getting murkier by the day. And what has left us appalled and disappointed is the lackadaisical approach of the otherwise proactive and conservative central bank in dealing with the malaise. The Reserve Bank of India (RBI) has repeatedly claimed the banking system per se is not exposed to any systemic risks. But its report on the findings of the audit conducted on alleged banks is very vague. Neither has the RBI quantified the extent to which the banks have mis-sold products nor has the penalty on them been spelt out clearly. HDFC Bank, ICICI Bank and Axis Bank are expected to face the regulator's wrath sooner than the others. The fresh allegations on State Bank Of India (SBI), Punjab National Bank, Yes Bank, LIC and others is yet to get the regulator's attention. Unless the RBI comes down heavily on the defaulting banks and makes their penalty public, we doubt if its actions will be detrimental enough for other profit chasing financial institutions.

What was the 2008 financial crisis all about? It marked the collapse of several asset bubbles that had been created by unprecedented credit expansion. How did major central bankers respond to this crisis? They pumped in even more cheap money. But we're extremely sceptical this treatment will work.

Central banks in the US, Japan and Europe have been printing money. Where does this money go in a scenario of near-zero interest rates? Risky financial assets! This is the reason why stock markets across the globe have been soaring. There has been no meaningful shift in economic fundamentals.

One of the main advocates of this reckless money printing drive has been Mr Ben Bernanke, the Chairman of the US Federal Reserve. In fact, some even call the ongoing rally in global asset prices the 'Bernanke asset bubble'.

Wouldn't it be interesting to know what Mr Bernanke himself thinks about this matter? An article in Livemint highlights some of his recent comments. In a recent speech, he appears to have said that there signs of excessive risk taking in the financial sector. In his arcane style, he even appears to have admitted that the growing distortion between fundamentals and asset prices could be risky.

What does this imply for Indian investors? Much of the rally in Indian stocks in recent times has been driven by Foreign Institutional Investors (FIIs) because of the cheap global liquidity. And as you know, FIIs are the most fickle lot among all investor classes. Any negative developments elsewhere could force them to flee away from Indian markets. And that could bring stock prices tumbling.

In the meanwhile after opening the day on a negative note, Indian equity markets continued to languish in the red. At the time of writing, the Sensex was down by about 272 points (1.35%). The other major Asian equity markets have closed the day on a mixed note with Japan and Malaysia leading the gains in the region while Hong Kong and Indonesia have closed the day in the red.

 Today's investing mantra
"An investment operation is one which, upon thorough analysis promises safety of principal and adequate retur" - Benjamin Graham

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3 Responses to "Things to know for buying a dividend stock"

meenakshi pai

May 19, 2013

While I agree with the note of caution in well worded article,my point is so much FII inflow has not made any significant valuation of INR,while sensex nifty scaling higher high,retailer seems to be still not enthused,the risk of foreign flow get out of system is a big hang,I follow the stock select very carefully and that is all about my stand.Greetings!

Like (1)

monish gaur

May 16, 2013

past dividend paying history
dividend yield
dividend cut off dates
valuation post dividend
lineage........tata, birla, godreaj, adani.......
psu, psb will pay higher dividend than hdfc,icici bank or hdfc bank or an axis bank in yield terms.....chill

Like (1)

monish gaur

May 16, 2013

please do not skip the primary points and emphasise the other ones, i mean it seriously that woods r any day btter than trees, unless the trees are of chandan and out value the woods. remember the following in indian context

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