Should you buy these stocks for 'invisible' dividends? - The 5 Minute WrapUp by Equitymaster
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Should you buy these stocks for 'invisible' dividends?

May 12, 2015

In this issue:
» Should you give in to temptation of bonus shares?
» Can the BRICS Bank help fund Indian Infrastructure?
» Mumbai's Shanghai dreams looks bleak
» China is taking baby steps to disaster?
»  ...and more!

How often do you buy goods on sale? With the advent of e-commerce, buying stuff on 'sale' is no longer an annual or bi-annual indulgence. And more often than not, it's not the discount on the products but the freebies that attract you to the sale. Whether or not the freebies have enough value is something that hardly matters, because they are not to be paid for! And thus the freebies become the lynchpin for inducing you to buy stuff you may not even need.

Now the greed for freebies could extend well beyond your shopping list. It could impact your investments too! If company managements have their way, they can very well stoke prices by offering free goodies to shareholders. What we are referring to here are the extraordinary payments made to shareholders. It is not unusual for companies to offer a big one time dividend to shareholders. And such instances do often fetch premium valuations for the stock. But since the receipt of dividend is more or less a regular phenomenon, this is not perceived as a freebie.

What typically delight shareholders are the completely unexpected or 'invisible' payouts: primarily the issue of bonus shares. Since such issuance is not regular and not based on events, share holders perceive this as a rare freebie. Often dubbed as 'invisible dividend', since the bonus share comes straight from the company's reserves, it gives the perception of being invested in a cash rich company. And hence investors are often on the lookout for such freebies. Even if the underlying stock is not a great fit for their portfolio!

It is true that companies with strong cash flows and ample reserves should reward shareholders occasionally with bonus shares. However, the problem occurs when companies do so only with the intent of sub-dividing the stock price to make it 'appear' cheaper or to stoke the valuations temporarily. This is more often the case in bull markets, when along with some genuine bonus issues; companies with questionable fundamentals follow the act to appease investors.

As per Business Standard, in the first four months of 2015 alone, around 21 companies have issued bonus shares. And nearly half of them have posted just single digit profit growth for the past fiscal. The fact that the companies are using a form of accounting jugglery should be a worry for long term shareholders. On the contrary the bonus issue more often than not acts as a trigger for the stock price moving up.

Thus as potential owners of the company, you should be more worried about whether the management puts resources to the most optimum use or tends to play to the gallery as per market sentiments. If it is the latter, you would be better off staying away from buying the stocks despite the lure of invisible dividends.

Do you buy stocks purely in anticipation of bonus issues? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
It's no secret that infrastructure has been the Indian economy's Achilles heel. While projects are being cleared quickly under the NDA government, the sector is yet to revive. The reason is not hard to find: financing. Getting funds for large infra projects is challenging even in the best of times. In times of tight credit conditions it can be next to impossible. The chart below shows the massive shortfall (about Rs 14.61 trillion) in India's infra financing. This deficit pertains to only half of the requirement. We are assuming the government will chip in with its 50% share of the estimated US$ 1 trillion needed for India's infra development. These numbers are indeed mind-boggling. However, there seems to be a ray of hope.

Can the BRICS bank bridge this funding gap?

It has been announced that veteran banker K.V. Kamath will be the first chief of the newly formed BRICS Bank. The bank with an initial corpus of US$ 50 bn and a currency chest of US$ 100 bn holds some promise for India's beleaguered infra sector. With an Indian at the helm of affairs, large projects of national importance can certainly look forward to funding from the BRICS Bank. However, it would not be wise to expect any miracles on this front. India's infra funding gap is just too big to be filled by the BRICS Bank on its own we believe. Mr. Kamath will have a very challenging task catering the funding requirements of many developing countries.

If you reside in the city of Mumbai, the new development plan (DP) would surely have caught your attention. For a minute let us leave aside the fact that the DP was flawed. No doubt it deserved to be scrapped. However, the question that arises is, 'what next'? It will take some time for a new proposal to be made. Until then, realty developers have been left high and dry. There is no clarity regarding crucial issues like floor space index (FSI) and public transportation. Even if a new proposal is made soon, what is the guarantee that it too will not be flawed? As per an article in Livemint, the delay is likely to push the sector into further disarray. Project delays and funding problems will become even more acute. Without a clear long term development plan, Mumbai's dreams of becoming Shanghai will remain just that, a dream.

Meanwhile, China is taking baby steps to stimulate the economy. The Chinese policy makers are the central bank are hardly in an enviable position. Several competing challenges such deflation, excessive debt; currency crisis and resistance to reforms are threatening to bring the economy to a complete halt. And hence the small rate cuts are attempted at pushing the economy back on track. Interestingly economists believe that the People's Bank of China governor is being too timid. And that he should be taking lessons from Japan's deflationary situation in 1998. Burdened by a massive debt buildup, graying population and rigid industrial policies, Japan chose to cut rates aggressively. And trend it has hardly been able to reverse till date. And the US' quantitative easing (QE), which was inspired by Japanese rate cuts, has also not seen an exit yet. That neither of the economies have enjoyed any real benefit from the near zero interest rate regime is another matter altogether. Thus we believe that the critics of China's slow interest rate cuts are offering the readymade QE solution without giving enough thought to long term implications. And faster rate cuts are not going to bring in results for China that will be different from what they did to Japan or the US. Which means rate cuts or not, investors must brace for lower global GDP growth rates, with the Chinese juggernaut slowing down.

The Indian stock markets were trading deep in the red. The BSE-Sensex was trading down 573 points (2.1%) at the time of writing. Capital goods and banking stocks were leading the losers. The midcap and small cap indices were also trading down between 1.5 and 1.6%. Asian indices ended mixed today with Shanghai leading the gainers and Hong Kong leading the losers. European indices have opened on a negative note.

 Today's investing mantra
"Accounting numbers are the language of business and as such are of enormous help to anyone evaluating the worth of a business and tracking its progress...Managers and owners need to remember, however, that accounting is but an aid to business thinking, never a substitute for it." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee.

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4 Responses to "Should you buy these stocks for 'invisible' dividends?"

Vivek Shanbhag

May 31, 2015

Other things remaining equal, a bonus issue provides a good opportunity to get capital appreciation in a tax efficient manner. Of course, one needs to be wary of companies who are using the bonus route merely to get people to buy, but are lacking in fundamentals like earnings, the ability to service the increased capital, etc. The crux lies in one's ability to discern the difference between these two types of companies.



May 15, 2015

No,I buy stock looking at its fundamentals


subhas biswas

May 14, 2015

yes it creat value in time



May 12, 2015

i buy shares for bonusshares only irrespective of value

Like (2)
Equitymaster requests your view! Post a comment on "Should you buy these stocks for 'invisible' dividends?". Click here!
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  1. Buy recommendation: This means that the investor could consider buying the concerned stock at current market price keeping in mind the tenure and objective of the recommendation service.
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