Are dividend stocks currently your best bet? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Are dividend stocks currently your best bet? 

A  A  A
In this issue:
» The relation between gold price and QE mechanism
» Why India should take Nokia's exit plan seriously?
» How food security bill is hurting investor confidence?
» Reasons for turmoil in India's growth
» ...and more!

Dividends offer a constant income stream. They are an important component of total return. As such, high dividend yield stocks are favoured by many investors including Warren Buffett. If the payout ratio is stable, dividends happen to be an important source of income during times of volatility. Hence, there is no denying over the importance of dividends, as a source of income.

However, as prudence says, value of anything is determined by its opportunity cost. In other words, had the dividends not been paid and ploughed back where would the investor stand in terms of total return? Dividends offer instant gratification. However, if they are reinvested in the business there is a back end benefit in terms of increased stock price. This happens when business has ample investment opportunities that generate good returns.

Let us assume that a company is generating 15% return on capital. If the dividends are re-invested into the business they compound at the same rate, ceteris paribus. Now assume that the same company pays out dividends rather than re-investing in the business. In this case, investors receive dividends. Now if they were to re-invest the cash flow they ought to find an investment avenue that yields 15%. If not, receipt of dividends turns out to be inefficient for them from a total return perspective. Imagine the difference in return that could erupt from the compounding effect over a longer period!

This is just the one drawback of dividends . If the company offering high dividends is fundamentally unstable or too expensive or lacks good corporate governance practices, it may be worthwhile to give it a pass.

However, this does not mean that one should not buy high dividend stocks. The cash flow received from dividends offers a fixed income stream. It's a good supplementary income. Consistent dividend payments also signal the cash generating capability of the business. Dividends also offer cushion when stock price experiences volatility. Thus, there are benefits attached to dividends.

But investors should keep in mind that dividends are not the most efficient source of return when considered from a tax perspective. Also, the compounding effect of re-investment that comes from ploughing the profits back outperforms dividend payment over the long term.

Are you aware of these drawbacks arising from investing in high dividend stocks? Please share your comments or post them on our Facebook page / Google+ page

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01:40  Chart of the day
Brands ensure stickiness. And stickiness enables repeat purchases. This presents stability to the companies. It is always difficult to uproot companies with strong brands because of sheer recall power they command. In today's chart of the day, we take a look at the top five consumer brands in India. The rankings have been awarded based on consumer reach points (CRP) . CRP's have been arrived after taking into consideration the penetration levels and frequency of purchases. Penetration refers to number of families purchasing the brand while frequency refers as to how often the person bought the brand. Both these factors are used to arrive at the final CRP figure. Today's chart shows that Colgate is the number one brand in India with 1,300 odd CRP's. Nonetheless, the presence of Ghadi, a detergent powder, in fifth place comes in as a little surprise. However, the detergent's strong recall in the semi-urban and rural India pretty much justifies its position in the top five list.

Data source: Kantar world panel's brand footprint report, Yahoo finance

Trend in gold prices and the Fed's policy moves have once again captured the imagination of speculators. As a result, notwithstanding of the Fed's inability to roll back QE and gold's fundamentals, the metal's prices are extremely volatile. Bullion is set to record an annual drop for the first time in 13 years. As a result speculators believe that investors might lose faith in the metal as a store of value. In fact, as per Moneynews, gold bears are predicting a correction in gold prices in coming months, after recording 17% gains since June 2013. Demand from Asia in particular has help gold prices resurge in the past few months. That Indian government imposed curbs on gold imports have not helped either. In fact there are reports of more gold now being smuggled into the country. Whether or not the US Fed will be able to roll back its QE measures is anybody's guess. But the global macro-economic scenario and India's myopic view on gold imports will only make the yellow metal more appealing to investors. Hence we would rather stick to our stance that investors must keep a small portion of their assets in gold.

Former disinvestment minister, Arun Shourie, has joined the club of people who are against the Food Security Bill . In a recent interview to a leading daily, he has stated that the Bill must not be passed. His reason is that the Bill reflects the lack of fiscal discipline and would only hurt India in the long run rather than helping it. Interestingly, Mr Shourie is against all the populist measures that have been advocated by the government. This includes subsidies, the NREGA scheme as well as the Food Bill. He thinks that instead of spending money on these issues, the government would be better off in allocating money to remove the structural roadblocks. That would help renew investor confidence in the Indian economy; something that has been waning in recent times.

His view on the recent policy changes announced by the government seems to echo our views. Simply raising FDI limits does not really help unless the government can create an environment that is investor friendly. Unfortunately the government has done very little on this front.

The government has been doing everything it can to portray itself as a people friendly government. Whether this would help it win the upcoming elections or not is anybody's guess. But its efforts, or the lack of it, have certainly hurt the Indian economy rather than helping it.

These are dark times for Indian economy with a lot of things going wrong. Slow growth, current account deficit and plunging rupee - all point out to the government's apathy and policy paralysis over years. And even now, the government instead of acting to minimize the damage is just making it worse. As per a leading financial daily, Nokia believes India is the least favourable market to operate. In fact, is thinking to quit India and shift its operations to China. The issue stems from lack of clarity on tax policies. The same may lead to hefty penalties against the firm. It is not a small issue related to just one firm. A lot of other MNCs such as Cadbury and Vodafone have had similar experiences in India. Nokia's reaction should be taken as feedback about how foreign companies feel about operating in the country. Lack of transparency and policy paralysis is the reason why foreign companies are not stepping in despite relaxing the FDI limits. India already stands vulnerable and is hardly in a position to take further blows. When so much seems to be going wrong, we cannot afford to annoy and lose the few MNCs that are present in the country. Hope the policymakers are listening.

The period between 2003 and 2008 saw India grow by leaps and bounds. GDP growth surged. Stock markets began their upward trend. There was a general feeling of well being everywhere. An article in the Economist points out that those years would have been the perfect time for the government to introduce some ground breaking reforms. Especially those related to land, labour and infrastructure. Sadly, that did not happen and India missed out on a big opportunity. The apathy towards reforms then continues even today. But this is further compounded by weak conditions globally and a deteriorating economic picture back home. India is grappling with high inflation, steadily falling rupee, rising deficits and loss of confidence from investors. The problem is that most of the solutions that the government has been coming up with are quite short term in nature. There seems to be no thought process involved in looking at the bigger picture and making changes structurally. Despite so much pressure on the rupee, we are still not in the same precarious state that we were in back in 1991. Having said that, the 1991 crisis pushed the government into introducing and implementing key reforms. And one hopes that this crisis compels them to do something similar.

Majority of the world indices ended in negative territory during the week gone by. Concerns over winding up of quantitative easing (QE) by the Federal Reserve kept the US markets volatile. However the negative impact was partially offset by a 13.4% fall in the US new home sales in July that raised hopes of a likely delay in the stimulus tapering. The key European markets including UK and France ended weak on uncertainty over cut in stimulus measures. However, the German market was up by 0.3%. This was aided by a strong 0.7% expansion in the German economy for the June quarter that raised hopes of the euro zone recovery.

Barring Japan, all the Asian indices have fallen during the week. Indian equity markets had been facing the brunt of the plunging value of the rupee against the dollar. However in the last two trading sessions, the markets showed some recovery with the rupee plugging the downfall on Friday after the finance minister said that the currency was undervalued. The rupee has settled at about 63.3 to USD$ after it hit a peak value of 65.5 to USD$ on 22nd August. The Reserve Bank of India (RBI) has said that it would continue with its monetary tightening steps until the rupee stabilizes.

Majority of the sectoral indices ended in the red with Pharma (down 3.6%), Auto (down 3.5%) and Realty (down 3.2%), witnessing the maximum losses. The metal stocks witnessed a huge spurt clocking a jump of 12.4% during the week. Shares from IT (up 1.4%), Oil and Gas (up 0.4%), Power (up 0.2%) were few of the other gainers. The Indian stock markets witnessed strong buying in Multi Commodity Exchange, Tata Steel, Sesa Goa, & Hindustan Zinc shares during the week.

Source: Yahoo finance, Equitymaster

04:50  Weekend investing mantra
"Owning stocks is like having children -- don't get involved with more than you can handle"- Peter Lynch
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4 Responses to "Are dividend stocks currently your best bet?"


Sep 1, 2013

Dividends were once considered as a regular stream of income, especially for pensioners and other retired people. Therefore, long term investments in "Blue Chip" scrips was an integral part of investment strategy. With the tax exemption given by FM Mr Chidambaram, the investment in such shares for long term became more attractive. However, with the advent of FIIs and other foreign investors the complexion of the stock market has undergone total change. Putting money in share market is no more and investment as was traditionally considered. Share prices moved up northwards and shares become more expensive. Investment in even blue chip shares is no more a source of regular stream of income as there are hardly any scrips which give dividend yield of around 5%. Investment in the best dividend yielding shares is no more attractive as a source of regular income stream as the cost of investment has gone up and yields have come down. Investment in the best defensive and high dividend yielding shares like HUL is no more attractive as the share price moved up from around Rs 200/- in around 2003-04 to over rs 700/- . The share market has become a gambling arena as even the best share collapses for no reason, when the nimble footed FIIs/ Foreign investors sell of shares to suit their purposes or at the slightest ruffles of rumors in the stock market, leaving the gullible domestic retail investors in the lurch. Unless one is very lucky, shrewd, alert and turns out to be "gambler" or modestly, a short term investor, one cannot hope to get any return from investment. Thus, dividends are no more a consideration while investing in the stock market.By the way, being not so well informed, can Equity Master list out some 10 shares which yield dividends of about 8%?



Aug 24, 2013

The purpose of investment is also to get a steady return for one's current expenditure. What is the point in accumulating wealth if you are not going to use it at least in part. A Sanskrit verse says "There is no greater than a MISER, for he gives his ALL WEALTH to others totally UNTOUCHED. There has to be a balance between accumulating blindly and spending lavishly. Dividends are for current expenses also.

Like (2)


Aug 24, 2013

u r bringing relevant points.Why anyone should be willing toinvest in india,when other BRIC countries are exportes and India importer.
India is one of leading corrupt nations.Majority of money in FDI is our own indian money kept outside india.
Regarding July House Sales in US.My sun bought his house in hurry when market was at peak.
It went down 30% when i visited 4 years 2 months back,he told me Prices have come back to his buying level.Therefore their will be lessbuying with QE considerations.

Like (1)

B R Bhutani

Aug 24, 2013

Well,personally, I would any day opt for investment in a regular good dividend paying co. for the flg reasons
1) Dividend income is tax free
2) It proves cash generation capabilities of the company
3) It shows investor friendly bias of the management
4) Capital appreciation on a/c of the fact that ex-dividend price very soon becomes equal to cum-dividend price
5) Psychologically too, it is nice to receive cash w/o having to sell the shares!

Like (1)
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