Are you ignoring this very useful fact about stocks? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Are you ignoring this very useful fact about stocks? 

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In this issue:
» The stock market has turned into a casino, says John Bogle
» How on earth will Japan repay its extremely high debt?
» MNCs emerged as best bet for investors
» Romney would bring a double dip recession, feels Krugman
» ...and more!

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An important question to begin with. What percent of your portfolio returns over the past few years have come out of dividends? Chances are that most of us would have simply overlooked this fact. After all, India is a growing economy and hence, why would companies pay out dividends. They would rather reinvest the excess profits back into the business so that the growth of the future years can be funded. Thus, we are perfectly fine with the management not paying out any dividends for the first few years as the company is in a high growth phase. It can of course do so when it becomes a mature company and can no longer grow at high rates. The excess funds in this case can thus be paid out as dividends.

The above argument is perfectly rational, isn't it? And it does make a lot of sense. However, the problem is that it has few assumptions built into it that are not in sync with the real world. Waiting too long for dividends to fructify may not be the most ideal way to invest we believe. This is because dividends should form a crucial component of one's total investment returns. How crucial? Well, if a study by PIMCO is to be believed, during decade long periods starting from 1930, dividends have on an average accounted for more than 40% of the total returns given by stocks.

This is quite an insightful data we believe. And this has couple of implications for investors who ignore dividend payouts and chase high growth instead. Firstly, the promise of high dividends by high growth companies would never materialise. This is because most such companies would continue absorbing a lot of capex and not really end up throwing any excess cash that can be paid out as dividends. Secondly, by insisting on a certain dividend yield, we don't end up overpaying for the company and it also keeps us from investing in companies that have only promises to show and nothing else.

Thus, investing in strong dividend paying companies and also at a reasonable enough yield may not be the most exciting way to invest out there we believe. But as data from PIMCO shows, it certainly carries lot less risks and also promises an attractive enough return in the long term.

Do you think dividends should form an important component in your total returns from stocks? Share your views or you can also comment on Facebook page / Google+ page

01:14  Chart of the day
Today's chart of the day highlights how FII holding in Nifty stocks touched a six year high recently. Well, this good news has coincided with the bad news that retail investors have seen their shareholding fall to a six year low as they kept their distance from stock markets. However foreign Institutional Investors (FIIs) showing more faith in India despite all its problems is a welcome sign indeed. It shows that India is certainly one of the most attractive long term markets out there and that Indian equities would continue to give good returns to investors who invest based on fundamentals and valuations. We hope retail investors too come back to the markets and become a beneficiary of the long term India growth story.

Source: LiveMint

The current year could be a turning point in the evolution of oil markets. As per the latest reports, oil supply pattern may witness a tectonic shift. A better technology and the rising oil prices have boosted domestic drilling in US. So much so that crude oil production in US this year is likely to witness highest gains in the last 60 years with annual production just marginally lower than Saudi Arabia. If the trend continues, it won't be too long before US takes over world leaders like Russia and even Saudi Arabia in oil production.

Will this lead to an era of cheaper fuels? It will be naive to predict the long term trend with surety for this capricious commodity. Oil prices in the past have been governed more by speculation than fundamentals. Nonetheless, the trend if it continues is likely to take some heat off oil markets.

What is the function of financial markets in an economy? One of the most important roles that markets play is enabling mobilisation of financial resources. Simply put, they help in allocating capital to businesses which in turn can create jobs and so on. Now, the thing is that the world of textbooks is very different from the real world. In reality, people are driven more by greed than by reason. Correspondingly, financial markets are increasingly manipulated by speculators than investors.

In his latest book titled The Clash of the Culture: Investment vs. Speculation, John Bogle has penned down the ugly truths about Wall Street. The name 'John Bogle' may not be very popular in India. But in the US, he is known as the godfather of the mutual fund industry. The octogenarian believes that speculators have taken over the financial markets, leaving genuine investors sidelined. In his book, he has pointed out how when he started his career in 1951, the average share of stock was traded once every seven years. Now, it is traded every four months. As per Bogle, Wall Street has turned into a big casino. Here it is the small investor who always loses.

We believe that Mr Bogle has indeed spelled out some real truths about the financial markets. In our opinion, if an investor follows the principles of value investing in a disciplined manner, he can save his hard-earned money from being hijacked by speculators.

The Economic Times conducted a study on the shareholder returns generated by 114 companies over the past 5 years. Amongst these were multi nationals (MNCs), professionally-run domestic firms, promoter-run companies and government owned ones (PSUs). MNC giants like Nestle topped the list of entities that maximized shareholder returns since 2008. Professionally run and promoter run entities were the next to join the list. PSUs on the other hand lagged when it came to enriching minority shareholders.

Undoubtedly the management's intent and ability to create wealth for shareholders counts tremendously in the long term. The PSU managements are therefore to an extent paralysed. Particularly due to their limited say in the government's decision making. There are some PSUs that are more profitable or more efficient than private sector peers. However, most of the management decisions are skewed towards social benefit rather than profitability. Again, it would be wrong to assume that every MNC can make investors rich. For there are several that have done nothing to please minority shareholders in India. In the case of MNCs like Nestle, it is the business model and the company's moat rather than the MNC management that needs to be credited for wealth creation.

Sovereign debt issues have plagued the developed world. In fact, many countries in the West are living dangerously with very high levels of sovereign debt. But one country which deserves a special mention here is Japan. The sovereign debt to revenue ratio of Japan is approximately 1,900%. Yes, you read that right!

One might wonder how the country in the first place was able to issue so much debt. And once it issued the debt, how was it able to survive? The reason Japan was able to issue so much debt was because of higher propensity of Japanese to save. The money saved was invested in government securities which piled up the national debt. But now as the population has started ageing, this debt will have to be liquidated.

Looking at the quantum of debt that is to be repaid (1,900% of the government's revenues) the country might default unless the government starts a reckless money printing exercise. But that would only fuel inflation. Thus, there seems to be no way out of the current debt mess for Japan. If the government had invested the money (of the savers) in private sector, it would have boosted the nation's productivity. But that money flowed into wasteful government projects. And now the country is paying the price for it.

Not that the US is not in a bad shape already. But Paul Krugman believes that if Republican candidate usurps current President Barack Obama in the upcoming presidential elections, then the US faces the prospect of a double dip recession. Being a Republican, Mitt Romney is most likely to cut taxes and reduce government spending. The former move will benefit the rich more and the latter will largely affect the poor and the middle class. The Democrats, on the other hand, have been advocating more taxes on the rich and resorting to money printing.

Interestingly, US' fiscal deficit is so high that taxing the rich more may not necessarily be enough to bridge this gap. Moreover, as long as the government keeps introducing more and more stimulus measures, this deficit will only bloat. But at the same time one cannot forget the fact that US got itself into such a sticky situation during the time the Republican party was in power. So the solution is not as simple as it seems. And maybe it is time that the US comes out with something entirely new.

Meanwhile, indices in equity market of India were trading above the dotted line with the Sensex higher by about 40 points at the time of writing. Oil & gas and auto stocks were seen attracting the maximum interest. While Asian indices closed mixed today, Europe was trading mostly in the green.

04:53  Today's Investing Mantra
"If you're good at valuing companies, the market will agree with you. I just don't guarantee when. It could be a couple of weeks or it could be two to three years" - Joel Greenblatt
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6 Responses to "Are you ignoring this very useful fact about stocks?"


Oct 29, 2012

A good management should pay some percentage of profit as divident, say 40%. Even enactment of law Govt is desirable. Inspite of good intetion of investing profits for growth, it may not be achieved due to unpredictable business environemt.Coys have a tendency the bolw excess cash. So dividend yield is an important aspect of investment.


TMJ. Jayan

Oct 28, 2012

I read your sample reports on Companies. You are only listing the names of top management. What about your comments on them. We may judge them by performance figures of the companies, but what about quality judgement from the analysts ? we need your rating/comment on this aspect, as well as business evaluation in terms of stability & earnings



Oct 26, 2012

vegetable trader pay interest of Rs 50 per thousand per day, Agriculture and construction labor pay rs 30/day per 1000. Where as companies promoted by rich and managed by MBA's hardly pay Rs 0.1 per 1000 per quarter. Why efficiency of educated and people of knowledge is giving poor returns on investment is only because of non commitment from promoters.



Oct 25, 2012

I believe the "Dividend Payout" should be an important part of one's portfolio. Hence high dividend paying scrips are always welcome. I however would like to know what is considered a fair "dividend earning" on the invested amount or the market value of one's portfolio? To my experience it remains within 1 to 2% of the market value of portfolio. (of course this is tax free.) Is that a normal range? It is also seen that the Growth plus the dividend say for a period of 3 years does not seem to match earning one could get on fixed deposits, because the portfolio always is mixture of weak as well as strong companies. Some light on this will be highly appreciated.
regards. MKV


Adi Daruwalla

Oct 25, 2012

Easy Come, Easy Go, Very High, Very Low, thats how equities move for a layman. Well PIMCO has done great research from 1930 onwards but the Gold standard was removed in 1973, and from there on there has been a free float for all major currencies of the wordl except for 58 - 63 countries. Well with the US, UK and even Germany prinitng the paper money, where is the real back up in terms of trade. Plenty of Gold reserves in the US, not in Knocks, but in Nevada etc, plenty of reserves in Germany. But what will happen to the stocks of the developing countires in India (so called developed). In the next few years til 2020 we will see an erosion of welath in India with all this lose money coming in. Normally the equation is if it has happened abroad it will happen here. If good happens there it happens here, if bad happens there it happens here, the chain continues. We dont need rocket science to know the future, our Ravanas sitting at the head of govt are already burning the nation foget the effigies.


Umesh Sharma

Oct 25, 2012

A company is judged by its capacity to service debts.Similarly the shareholders fund are like a debt although the company does not have to sign loan documents its prudent to consider the company's ability to give reasonable returns out of the profits earned as essential
quality.The shareholders may contribute the capital but they do not participate in the running of the company.When all other expenses are accounted for there is no reason to exclude the dividends payable to share holders from the cash flow calculations.In fact deferring the dividends on the pretext of building capex gives rise to unwanted manipulations.There is no reason why the company should resort to internal accruals for funding new projects /expansion.the share holders who contributed initially will not hesitate to contribute further capital if the company is well managed and keeps its shareholders happy by giving out generous dividends.So a good company has to ensure wealth building in addition to paying out reglar dividends and not only concentrate on wealth building by depriving the share holders their rightful dues

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