Are dividend stock investors foolish? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Are dividend stock investors foolish? 

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In this issue:
» Why don't central banks buy the stock markets outright?
» China's growth dangerous for human race, feels Krugman
» US Fed unveils more stimulus
» Who's behind Noida's current manufacturing plight?
» ....and more!

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Investing based on dividends is no doubt a good and powerful idea. This is because unlike most other financial parameters, this is the one that is most immune to manipulation. But like all good ideas, this too has been taken to the extreme we believe. So enamoured have investors become with dividends that at times they tend to overlook other factors. We feel the most dangerous of these is the reluctance to check out the actual source of the dividend of the company under consideration.

When asked why they have a certain stock in the portfolio, the investors cite its track record of high dividend payouts. But since it is a part of basket approach of picking stocks, they don't really bother to check out the details. And this is where the biggest errors occur.

You see, companies don't operate in isolation. Their business environment is subject to frequent changes. And thus, it is quite possible that the high return on capital that they enjoyed in the past has come down dramatically. In fact, this is the rule rather than the exception in the business world. But most such companies would still continue with their high dividend payouts. Because if they don't, the stock price of their firms could see a huge correction.

Thus, it is very important that an investor checks out the source of dividends of each and every firm that he has invested in. Because while you are looking at the return on your money, there's every chance that the dividend is actually the return of your money. Companies that don't quite earn the cost of their capital and still pay dividends are perhaps paying out the dividends from their capital. And sooner or later, they will run out of capital. Hence, dividend investing is no doubt a great thing. But do make sure that it is authentic enough. Otherwise, you would be made to look like a fool.

What are the factors that you take into account when investing in a dividend stock? Share your views or you can also comment on our Facebook page / Google+ page

01:06  Chart of the day
Economies of India and China may not exactly have the voice in matters of international trade in proportion to their economic size. But we believe that this could soon change. For their economic clout is only going to get bigger. Today's chart of the day highlights how these two nations have seen their share of global GDP go up in the last decade or so. While China now accounts for around 10% of global GDP as opposed to just 4% a decade back, India's contribution too has increased to 2.6% from 1.5% earlier. Meanwhile developed nations like US and Japan have seen their influence erode. What more, the trend is only likely to improve in favour of the Asian giants going forward.

Data source:

Should central banks buy stocks? Although it may sound ridiculous, the idea has indeed been put forth by a Citibank global strategist. Business Insider has published the interview of Citi analyst Robert Buckland. The gentleman is clearly not in favour of the low interest rate policy adopted by the US Fed. On the contrary he believes that low interest rates are increasingly part of the problem rather than the solution.

He also thinks that central banks' low interest rate policy is encouraging the wrong kind of corporate behaviour. Companies are using low interest rates to borrow money for share buyback. This makes companies capital distributors rather than investors! Instead they should be investing in additional capacities. The low investment in turn is hurting job creation. To discourage this behaviour, Buckland suggests that central banks should intervene in stock markets. This would stoke valuations and discourage share buybacks.

We could think of no other term to describe this suggestion than ludicrous. The gentleman is critical of the Fed's interventionist policies and then goes ahead and suggests an intervention himself. In our view, the Fed should just leave the markets alone and do away with intervention of even the remotest kind.

A major problem facing the world today is the growing dichotomy and conflict between the man-made world and the natural world. While industrialisation and information technology may have brought us several material comforts, this has not come free. Increasing concerns about climate change and environment are the price the world has to pay for all the economic excesses.

Economists have now started acknowledging this. Paul Krugman is one of them. Krugman says that the phenomenal growth in the Chinese economy may have been a great economic success. But this success is going to have far-reaching consequences for the globe. China has already emerged as the largest polluter in the world. Most of its power plants are coal based. Moreover, given its huge appetite for consumption, the dragon economy is also putting pressure on finite natural resources such as minerals, oil, etc. The worrying aspect is that China is not obligated to cut greenhouse gas emissions under the Kyoto Protocol. The reason for this is that when the treaty was being drafted in the 1990s, China was still a developing country.

Adverse changes in climate and environment are a major threat that will have significant ramifications for the global economy. Investors must take into consideration these risk factors before making their investment decisions.

Indian manufacturers are gradually learning a painful lesson as to why China is considered the manufacturing powerhouse of the world. Indeed, one has to look no further than Noida as an example. Manufacturers in Noida, especially those in electronics, are facing the possibility of an imminent shutdown. This is as cheap Chinese imports find their way into the market. So far Noida has prided itself of having one of the largest concentration of SMEs is the country. But this Chinese threat means that it is now seeing a proliferation of traders. For starters, there is a marginal gap between the duty imposed for components and finished products. As a result, there has been an increasing preference for importing finished products and selling them in the Indian market, thereby boosting the fortunes of traders. Is Noida the only region facing the threat of Chinese imports? Or are there such pockets elsewhere in the country? One is not sure. But it has been apparent in the past that while India made significant strides in the services sector, there was and will be considerable ground to gain before it earned the repute of the kind China enjoys in manufacturing.

How do you bring an economy from the brink of disaster back to life? Central banks across the world are trying various measures in order to revive their economies post the financial crisis and the subsequent recession. The US Federal Reserve has now announced its own unorthodox measure to help revive the economy. Fed Chairman, Ben Bernanke announced that interest rates would be kept at near zero levels until unemployment falls to at least 6.5%.

The Fed expects rates to hold steady until unemployment figures improve. This is as long as inflation doesn't break the 2.5% barrier. The central bank also replaced an expiring stimulus programme with a fresh round of Treasury purchases. While earlier goals were more timeline driven, these action oriented goals will make monetary policy more transparent and predictable to the public. But, despite all these efforts, GDP growth in the US remains lukewarm. The upcoming fiscal cliff is also a matter of concern. Well, we just hope that new job creation will provide some respite to this ravaged economy.

The world's largest mutual fund, PIMCO, is not very optimistic on the global economy. It expects global economic growth to slow down to the range of 1.3% to 1.8% in 2013. This is lower than the current rate of 2%. The forecast of a slowdown is based on the poor performance of the private sector. As per PIMCO, the private sector is still showing signs of lower profits combined with lower rate of investments. This would lead the global economy's growth to stall next year.

PIMCO further expects the growth in US to drop to 1.25-1.75% from the current levels of 2.2%. This is on account of fiscal tightening which policy makers need to bring about to ward off the impending doom of a fiscal cliff. At the same time the latest round of quantitative easing has not really done its job either. It has been quite ineffective in boosting the growth the way the policymakers had envisaged it. Europe too has its own troubles to deal with. The Asian economies of China and Japan are victims of a slowdown too. All in all not a very bright picture for 2013 as far as the global economy is concerned.

Meanwhile, indices in the Indian stock markets are showing the same lacklustre signs today that they have shown all this week. At the time of writing, BSE Sensex was trading lower by around 20 points. FMCG and consumer durables stocks are seen facing the maximum pressure. While Asian stocks closed mixed today, European indices are trading with a positive bias.

04:56  Today's Investing Mantra
"Investing without research is like playing stud poker and never looking at the cards." - Peter Lynch
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3 Responses to "Are dividend stock investors foolish?"

Umesh Sharma

Dec 14, 2012

Healthy dividend payout is not only a sign of business prosperity but also indicates the honest intentions of the management to reward its shareholders handsomely.Some Indian companies are notorious for denying their shareholders a fair return on their investment while they enjoy high salaries and perks.Needless to say they rot in the share market as no one wants them.Having said that it may so happen that the business conditions may be affected adversely In such a case the management should explain to share holders the fact.In any case as they build-up reserves in good time it should not be difficult to pay dividend from reserves when occasionally the profits are not adequate.One should not be afraid of lower market worth when the conditions are not good.The management which believes in the intrinsic strengths of the company can always utilize such opportunities to buy back its share and keep the bears away.Even discerning investors welcome such opportunities for bargain hunting.However paying dividends out of capital is certainly not advisable as it sounds death knell for the company.



Dec 13, 2012

Along with dividends, we have to see Book Value, Turnover growth, PE ratio,and any special news about the company regarding future plans etc. It is always safe to identify dark horses and invest in them before they become more popular.


Abhay Dixit

Dec 13, 2012

The Chinese threat is more important to Indian industry and investors than "Are dividends-----?". There has been very little reporting on this issue both by companies and government. Indian Govts, over the years, are generally not willing to stand up to foreign governments--- strong or weak( be it China, US, Bangaladesh or Pakistan)-- to protect our interests.

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