Why you shouldn't buy all high dividend stocks?

Dec 9, 2013

In this issue:
» JP Morgan's nepotism for Chinese bureaucrats
» True unemployment rate in US is 13%
» First Chinese debt default on the anvil
» Swiss banks to divulge secrecy on US pressure
» ...and more!

Dividends are an important source of income. Many investors prefer high dividend yield stocks. High dividend payment also reflects management's generosity towards shareholders.

What more, dividends are also a reflection of the fundamental strength of a business to a certain extent. Hence, reduction in dividends may give a negative signal to the market. As a consequence, most companies prefer to have a consistency in dividend payments. Even if this means being more generous than what their financials allow.

As per an article in Business Standard, 40% of the firms that paid dividends in FY13 faced cash constraints. Over long term, the picture is even worse. Since the last 5 years, nearly half of the companies that paid dividends at least once had negative free cash flows.

Free cash flow is an important indicator of a company's ability to pay dividends. However, despite poor financial health, India Inc has appeared to be reluctant in reducing dividend payments. Most managements' fear an investor backlash subsequent to dividend cuts. Hence, some of them even borrow to pay dividends! For PSUs, the dividend and free cash flow divergence gets even wider. Being government owned, these companies generally have liberal pay outs. This is because the government is the direct beneficiary of this policy. High promoter owned companies also fall in this category.

Thus, it is clear that dividend policies can be managed. Hence, investors should not blindly buy stocks of high dividend paying companies. They should carefully assess the sustainability of high dividend payments. This can be done by analysing the cash generating capability of the business. If the cash flow is negative and dividend payments are increasing it is a sign of worry. This indicates an organization is probably funding dividends through borrowings. Such dividend payments are not sustainable.

On similar lines, companies that do not pay dividends should not necessarily be avoided. Capex heavy companies may not have sufficient cash to pay dividends. This does not mean they are bad investments if bought at the right valuations.

The bottomline is that dividends should not be the sole criterion for investments. Undoubtedly, high dividend paying companies give a sense of comfort. However, one should find out if such payments are sustainable and whether the policy is managed or not. If high dividends are due to better cash generating capability of the business, investors should then pay attention to fundamentals and management quality. Only then they should commit their money to any company.

Do you simply buy companies which have liberal dividend policies? Let us know your comments or post them on our Facebook page / Google+ page.

 Chart of the day
The consumer durable loan market has a small pie in the banks' overall lending portfolio. Its share stands at just Rs 1 bn. However, consumer durable loans have been growing at a hefty pace even after RBI banned the zero percent EMI schemes. Most of the zero percent schemes were used to promote consumer products like mobile phones, TV sets, refrigerators etc. Hence, ban on zero percent schemes should have dented the demand for consumer products and thus loans. However, as can be seen in today's chart, consumer finance loans have increased at a strong pace since the last 4-5 months. In fact, over the last four months in question the YoY growth has been above 30%.

The reason for such high growth is because of the support coming in from finance ministry. It may be noted that in October, finance ministry had announced that it will provide financial support to banks so that they can lend more money to individuals in order to finance the purchase of consumer products. In addition to that, many banks have also resorted to rate cuts on consumer finance loans so as to boost lending. This has led to increase in sales of consumer durables purchased via finance by about 80-90% this year. With lending slowing down in other sectors like infrastructure, power and real estate sector, consumer finance is proving to be a good option to weather the slowdown.

Growth in consumer durable loans

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What is the best way to raise money when deficit keeps widening and you simply can't tax people more and also at the same time can't reduce your expenditure? How about going after tax defaulters or dodgers? That's a good idea of bridging the gap isn't it? And this is exactly the modus operandi the US authorities seem to be adopting currently. Financial Express reports how the US is exerting pressure on Swiss Banks to lift the veil of secrecy under which they've been operating for years now.

In fact, Swiss banks have been given a deadline of today to decide if they want to participate in a US Government program. The program could force Swiss banks to settle tax evasion charges and also disclose names of investors suspected of using Swiss accounts to evade taxes in the US. Well, we wonder if the Indian Government can show some spine to follow in on US' footsteps. Given how most of those in the Government are themselves likely to be involved in stashing black money abroad, such a move simply cannot materialise. Almost impossible, isn't it?

Instances of bribery and corruption are commonplace in India. However, it seems that economies in the West have devised more innovative ways of bribery than anyone can imagine. And at the centre of it is a too big to fail bank. As per an article in Indian Express, leading investment bank JP Morgan has a rather perplexing hiring policy. The bank gives special preference to children of bureaucrats. The "Sons and Daughters" hiring programme has been at the center of a federal bribery investigation for months.

The investigation revealed that the bank used such hiring to further its own interests. In one such instance, a prominent hire actually helped the bank fetch business from a Chinese government-run company. Thus, the payoff to the bank for the special hiring was by way of lucrative deals. We do not think this can be termed as anything but bribery or corruption. And we will not be surprised if such hand-in-glove arrangements are dug out with officials of Indian PSUs as well. Probably, this could be yet another area the CAG needs to look into.

Too much of anything is bad. So is the case with debt. Too much of debt can be dangerous. China is currently facing such a situation. Consider these facts reported by Bloomberg. A record 2.6 trillion Yuan (US$ 427 billion) of interest and principal on securities issued by non-financial companies would be due in 2014. To give a sense of the magnitude of debt, this is 2 times the economy of Ireland. And 19% higher than the current year!

It is worth noting that there have been no defaults in China's publicly traded domestic debt market since 1997 when the central bank started regulating it. But this trend could soon end as maturing debt reaches a record high next year. What is worse is that interest rates in China are increasing. Against the backdrop of a slowing economy, this seems like a recipe for disaster. Needless to say, this has raised concerns about the likelihood of corporate bond defaults in the dragon economy. If the defaults spiral up, it could destabilise the world's second largest economy. And this in turn could cause turbulence in the world economy as well.

The latest jobs data in the US would have given the government much cause for cheer. After all, as reported in Moneynews, the headline number for unemployment fell to a five-year low of 7% last month. Non-farm payrolls also increased by 203,000 in November. But the reality seems to be quite different. At least that is what Peter Morici, a professor at the University of Maryland believes. He is of the view that the true unemployment rate is 13%. And the current data does not take this into account on account of several factors. For instance, if one counts the people who have given up looking for work or are working less than they'd like, then the actualunemployment rate is much higher than what the US data suggests. This is a problem that both the younger and older population is facing. Especially, the young graduates who are not finding work, or the older people who have lost their jobs. Even if the non-farm payroll data shows an increase, there is no proof that these are high quality jobs. The only silver lining is that though the job improvement is not to the standards it should be, it is still better than the previous months. This is hardly something that provides comfort and only indicates that things may not be the same for the US for a long time.

In the meanwhile Indian Equity markets continued to trade strong due to the outcome of assembly elections. At the time of writing, the benchmark BSE Sensex was up by 320 points. All the sectoral indices are trading strong, barring stocks from consumer durables. Stocks from Banking and Capital goods spaces are the top performers. All the other Asian stock markets except Singapore were trading strong led by Japan.

 Today's investing mantra
"If past history was all there was to the game, the richest people would be librarians" - Warren Buffett

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4 Responses to "Why you shouldn't buy all high dividend stocks?"

sunil kumar oberoi

Dec 18, 2013

the invester not only depend on divident,their motto how to gain more money in short period so he can tried their best to purchase those co. which growth quickly.

Like (2)

raveendra kumar

Dec 10, 2013

I prefers the companies that have fundamentally strong and which scores growth rate consistently. Dividend pay outs are not the measure of the success of any company

Like (3)


Dec 9, 2013

Yes, I seldom invest in a company that does not pay dividends.

Like (4)

SN malhotra

Dec 9, 2013

A distinction probably has to be made between low net cash availability from capex expenditure and other reasons like low margins, shrinking mkt share etc.
in the first case I believe it is ok to pay dividends as the capex could be partly funded by borrowings

Like (1)
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