Free Reports

A tale of rising dividends and falling profits!

Jun 16, 2015

In this issue:
» Beware of the most common mistake in investing!
» China's leveraged stock market boom reaches precarious levels!
» Round up on the markets
» ...and more!


00:00
A few days ago, we had written about the dividend bonanza enjoyed by shareholders of some stocks. These were mostly stocks backed by strong company fundamentals. Being value investors, the dividends are an important factor when we select stocks. A regular dividend payout history is a clear sign of a fundamentally sound company. While earnings can be manipulated by creative accounting, dividends cannot be as it is a cash transaction. However, we don't recommend that you fill up your portfolio with high dividend stocks. There is more to this story.

Dividends are supposed to be a sign of confidence that the management has in the business. It is a sign that the business is throwing off excess cash. To quote Warren Buffet; "Almost by definition, a really good business generates far more money (at least after its early years) than it can use internally" . Thus, if a business generates cash greater than its internal needs, we believe the management should return it to shareholders. The key issue is how this is done.

Many firms have a stated dividend policy. The annual report may state the percentage of profits the company will pay out. If the board of directors increases the dividend, it should imply that profits too have increased. However, we came across an article in the Economic Times that found the opposite to be true! 20% of companies that were analysed increased dividends despite a fall in the bottomline. If you own shares in such a company, should you be worried?

We believe the answer can be found only by digging a little deeper. The following questions should come to your mind. Was the profit decline only due to a one-off event? Is the business generating strong operating cash flow as before? Is the management struggling to find growth opportunities? Has debt been taken to fund the dividend payout? Unsatisfactory answers to these questions should ring alarm bells.

Keep in mind that the best dividend paying firms usually have a few things in common. Solid underlying businesses, shareholder friendly managements and strong operating cash flows are the most important ones. If this is not the case with the stocks that you own, you should not take the management's positive views at face value. It could be a case of promoters enriching themselves via higher payouts.

However, a temporary fall the net profit may not necessarily be a cause of worry. For example two of the companies listed by the financial daily, Bajaj Auto and Mahindra & Mahindra, had a challenging year in FY15. However, these businesses have a strong historical track record which investors will have to factor in. So while dividends are important, we believe it should only act as a starting point for your analysis. Dividends are not an end in themselves. What really matters is the state of the business that generated it. As is the case with most things in life, dividend investing is not as simple as it appears to be!

Do you invest primarily for dividends? What do you look for in such stocks? Let us know your comments or share your views in the Equitymaster Club.

--- Advertisement ---
Is It Time To Be Greedy Or Fearful?

The stock markets have crashed and a number of stocks have taken a beating.

And now, many common investors feel it's better to stay away from stocks right now.

But what if we told you this could be an ideal time to get Greedy about stocks?

And not only that, what if we told you this is actually a wonderful opportunity to grab some very good stocks at bargain prices?

Yes, we've revealed details of 3 such stocks you could consider buying right away in our new special report... which you could obtain for absolutely FREE!

Click here for full details...

------------------------------


02:50
 Chart of the day
As the monsoons and earnings put a reality check on investor's expectations, the benchmark indices have witnessed some correction since their life time highs. And this we believe could be a great time to pick up fundamentally strong stocks for investors that have a long term horizon.

However, what seems to be an opportunity could turn out to be disaster if you get the concept of value investing wrong. Allow is to explain. We often come across queries and feedback that suggest that a particular stock is cheap and worth considering for recommendation as it is trading significantly lower than its 52 weeks high. We believe that nothing could be farther from truth. To decide whether a stock is trading cheap or expensive on the basis of absolute price is fallacious. After all, price is just a part of the equation. By itself, it is not enough to decide if a stock is trading cheap or expensive. Ideally, what you should be looking for is fundamentally strong stocks trading below their intrinsic value. If you ignore the former, chances are that you will end up with stocks making even new lows.

Does the recent correction imply a buying opportunity?

03:50
There seems to be a dichotomy between Chinese markets and economy. While the latter is struggling for growth, the market valuations suggest a different story. With real estate market cooling down, investors seem to have turned to stock markets.

However, as suggested in an article in Economic Times, there is more to what is driving the stock market boom amidst uncertain economic climate. The investors have not just put their savings at stake, but are using borrowed money to invest in markets. There has been a five times increase in margin lending, wherein brokerage firms lend money to investors to buy stocks. Further, it is expected that the total amount borrowed is even higher, including the amount borrowed from family and banks.

This puts to risk not just the stability of household finances, but the entire financial system. Especially because it seems that it is the stocks of small and relatively lesser known firms where investors are putting money in hope of quick gains. This is indeed a precarious situation. Unfortunately, if things go wrong, it won't be just China's problem. Considering the money that has poured into these markets from other economies, the consequences could be far reaching.

04:15
After opening the day in the red, the Indian stock markets moved into the positive territory. At the time of writing, the BSE-Sensex was trading higher by 100 points (+0.4%). Barring oil and gas, FMCG and realty, all sectoral indices were trading in the green with stocks in auto and consumer durables leading the gains.

04:40
 Today's investing mantra
"A public-opinion poll is no substitute for thought." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Richa Agarwal (Research Analyst).

Today's Premium Edition.

Lessons in succession planning from Vedanta Group

Pros & cons of involving and hiring outside managers in succession planning.
Read On...Get Access

Recent Articles

This Rs 71 Trillion Business Could Make or Break (Your) Wealth in the Next Decade October 17, 2017
How to profit from behavioral biases afflicting the industry.
Sometimes the Market Makes Me A Crazy Person October 14, 2017
It's necessary to guard yourself when euphoria surrounds the market.
A Grave Mistake Both Companies and Investors Make October 12, 2017
When a company is making acquisitions or an investor is buying shares, this one important factor cannot be ignored.
Timeless Stocks on the Electric Car Assembly Line October 10, 2017
Are they on their way to create Coca Cola-like wealth?

Equitymaster requests your view! Post a comment on "A tale of rising dividends and falling profits!". Click here!

2 Responses to "A tale of rising dividends and falling profits!"

Kerman Marolia

Jun 22, 2015

You are right. Dividend is not the criteria to judge a company's worth. It is the appreciation of the company's stock that should be considered.
However continuous refrain from giving dividend for a few years will definitely wil be a cause for worry.

Kerman Marolia

Like 

Ganapathy Sastri

Jun 17, 2015

Dividend yield theory is a fallacious theory and should not be given too much importance. You buy shares / stocks for future profits and nothing else. So work out your return by dividing FUTURE EPS by current share price and if it is acceptable, you may buy or decide otherwise.
The fact that a company like Bajaj Auto or Mahindra with its past track record has had a lower profits MAY be a matter of concern. One cannot assume that past will continue in the future. One has to evaluate / predict future profits and then decide. The recent fall in profits for these reputed companies may be a sign of decreasing future profits.

Like 
  
Equitymaster requests your view! Post a comment on "A tale of rising dividends and falling profits!". Click here!
DISCLOSURES UNDER SEBI (RESEARCH ANALYSTS) REGULATIONS, 2014
INTRODUCTION:
Equitymaster Agora Research Private Limited (hereinafter referred to as "Equitymaster"/"Company") was incorporated on October 25, 2007. Equitymaster is a joint venture between Quantum Information Services Private Limited (QIS) and Agora group. Equitymaster is a SEBI registered Research Analyst under the SEBI (Research Analysts) Regulations, 2014 with registration number INH000000537.

BUSINESS ACTIVITY:
An independent research initiative, Equitymaster is committed to providing honest and unbiased views, opinions and recommendations on various investment opportunities across asset classes.

DISCIPLINARY HISTORY:
There are no outstanding litigations against the Company, it subsidiaries and its Directors.

GENERAL TERMS AND CONDITIONS FOR RESEARCH REPORT:
For the terms and conditions for research reports click here.

DETAILS OF ASSOCIATES:
Details of Associates are available here.

DISCLOSURE WITH REGARDS TO OWNERSHIP AND MATERIAL CONFLICTS OF INTEREST:
  1. 'subject company' is a company on which a buy/sell/hold view or target price is given/changed in this Research Report
  2. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any financial interest in the subject company.
  3. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have actual/beneficial ownership of one percent or more securities of the subject company at the end of the month immediately preceding the date of publication of the research report.
  4. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any other material conflict of interest at the time of publication of the research report.
DISCLOSURE WITH REGARDS TO RECEIPT OF COMPENSATION:
  1. Neither Equitymaster nor it's Associates have received any compensation from the subject company in the past twelve months.
  2. Neither Equitymaster nor it's Associates have managed or co-managed public offering of securities for the subject company in the past twelve months.
  3. Neither Equitymaster nor it's Associates have received any compensation for investment banking or merchant banking or brokerage services from the subject company in the past twelve months.
  4. Neither Equitymaster nor it's Associates have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past twelve months.
  5. Neither Equitymaster nor it's Associates have received any compensation or other benefits from the subject company or third party in connection with the research report.
GENERAL DISCLOSURES:
  1. The Research Analyst has not served as an officer, director or employee of the subject company.
  2. Equitymaster or the Research Analyst has not been engaged in market making activity for the subject company.
Definitions of Terms Used:
  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.
  2. Hold recommendation: This means that the investor could consider holding on to the shares of the company until further update and not buy more of the stock at current market price.
  3. Buy at lower price: This means that the investor should wait for some correction in the market price so that the stock can be bought at more attractive valuations keeping in mind the tenure and the objective of the service.
  4. Sell recommendation: This means that the investor could consider selling the stock at current market price keeping in mind the objective of the recommendation service.
Feedback:
If you have any feedback or query or wish to report a matter, please do not hesitate to write to us.