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Don't Let Dividends Lower Your Portfolio Returns

Nov 5, 2015

In this issue:
» IPOs this year: A performance snapshot
» Will new bankruptcy code woo global investors
» ...and more!

00:00
'Do you know the only thing that gives me pleasure? It's to see my dividends coming in.'

John D Rockefeller's remark to his neighbor can easily be misconstrued.

Stocks hold huge appeal for investors who seek high returns, but they don't come without risk. No wonder many people prefer to play it safe with bonds or fixed deposits.

Dividend-paying stocks, however, offer a sweet mix of income and high risk-reward - a tempting lure indeed. A number of funds even invest on this theme and target investors looking for this mix. But dividend investing is hardly as simple as it seems.

Far too many investors focus on stocks with high yields or payout ratios. It's a shortsighted approach that can lead to disaster.

Numbers can and do lie...

We recently pulled data for high-dividend stocks. The results weren't encouraging...

A declining dividend sends negative signals to the market. This can compel companies to maintain dividends, even if it's not in the shareholders' long-term interest.

The data shows that many companies offering seemingly attractive yields have debt beyond our comfort levels. There is no dearth of companies offering yields above 2% but face negative free cash flows, which indicates that the company could be funding dividend payments through debt. This is not in the best interests of shareholders.

Who are these companies paying?

Interestingly, some of these companies are government owned. The promoter's stake in private companies is quite high, so generous dividends are mostly filling their own pockets with borrowed money, thus adding risks to the business. This hardly gels well with the aim of dividend investing that investors opt for safe returns.

Dividends have an opportunity cost...

A business' profits can either be paid as dividends or ploughed back into the business. If the management can manage and compound money better than the shareholders, dividends, which are taxable, may not be the best way to maximise shareholder value.

It is worth mentioning here that Berkshire Hathaway does not pay dividends. You can't hold it against Buffett; after all, his firm has made shareholders far wealthier though acquisitions and re-purchases than it would have had it paid out dividends instead.

Not all dividend stocks are equal...

Not all dividend stocks worth considering will be available at attractive valuations. Investing isn't just about dividends, but capital appreciation. Overpaying for dividend stocks can bring down returns. A stock available at a low price and a low valuation that offers a high dividend yield could be a sign that the business is in trouble.

High dividend payouts or yields are no substitute for good fundamentals and management quality. Make sure you do not chase the former at the cost of the latter.

If regular income is an important criterion for you, widen your focus from the latest dividend data and look for a clear, rational, and consistent dividend policy.

Are liberal dividends important criteria for you? How has your experience been using this approach? Let us know your comments or share your views in the Equitymaster Club.

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02:15
 Chart of the day
The IPO market is slowly gaining momentum. An article in Business Standard reports that about 16 companies listed on the Indian bourses in 2015 are via the IPO route.

A lot of IPO investors keep an eye on the listing day. It is the day of price discovery. If the IPO manages to generate significant demand in the secondary market, the listing day gains could be immense. It is no surprise then that many investors think of IPOs as one of the fastest ways to make quick gains.

So, let's have a look at how the IPOs performed this year. Apparently, eight of the 16 IPOs that hit the bourses this year opened in the red. So, if you had blindly invested in every IPO in the hope of listing day gains, there would have been a 50% chance of losing money. Nonetheless, the gainers did outperform the losers in terms of total returns. As such, if you would have allotted equal sums in each IPO, you would have still made positive gains. But in reality, this does not always happen. The more popular and lucrative IPOs tend to get oversubscribed, reducing the allotment of shares per investor. The other observation from the performance of IPOs this year is that you would have been better off had you held on to stocks instead of selling them off on the listing day.

Does this mean you should apply for IPOs and hold them for the long term? In our view, you can never make a generalised view about investing in IPOs. You have to evaluate the merits of each individual IPO and invest accordingly. But remember this piece of wisdom quoted by Warren Buffett on IPOs: ‘It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors).'

Top Listing Day Gainers & Losers of 2015

03:30
While Prime Minister Mr Modi has launched 'Make in India' drive, it has not been easy to win the confidence of global investors. One of the key reasons why India ranks lower on the parameter of ease of doing business is inefficient resolution of insolvency issues.

As an article in Firstpost suggests, a major break through is around the corner. The panel on new bankruptcy code has suggested a defined time frame of 180 days for dealing with insolvency resolution applications. This comes along with a proposal to establish an insolvency regulator and initiate process that could identify distress signals earlier in a firm and take remedial actions if they are found to be viable. The draft bill also proposes a fresh start for individual and unlimited liability partnership firms. This will certainly empower creditors by increasing accountability. Also, it can be a major factor in wooing investors on account of ease of entry and exit and timely resolution in case of distress.

04:15
At the time of writing, the Indian markets were trading in the red. The BSE Sensex was down by about 82 points. Losses are led by banking, realty and pharma sectors.The Midcap and smallcap indices were also trading lower.

04:30
 Today's investing mantra
"You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing" - Warren Buffett

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

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2 Responses to "Don't Let Dividends Lower Your Portfolio Returns"

Deepak Padher

Nov 9, 2015

Ha ! Ha ! If Berkshire Hathaway does not pay dividends then it is as good as investing in Gold.
In gold also I am not getting any dividend and I myself can assume that gold prices are increasing.
I remember a story in my village where a man has given money on loan to some person on interest and man who has taken money went on telling this man - Now you have this much amount of money with me including interest. This went on till first man passed away.

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Ganapathy Sastri

Nov 5, 2015

When you buy stocks, you buy future profits. Treat 100% of the future profits as your dividend ( even if you do no not get it) and work out your returns. Treat dividends as ROOM ( return of own money). Your true gains will be known based on your buying price minus dividends received compared with actual or notional selling price.

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Equitymaster requests your view! Post a comment on "Don't Let Dividends Lower Your Portfolio Returns". Click here!
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