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Dividend stocks: For a change

Feb 28, 2003

Which sector is going to lead the next rally? And what if the domestic indices do not rally? What could prevent the market upmove? Well, it could be anything! It could be software stocks if they fail to live up to the high expectations of the investor community. Or it could be the effect of bad monsoons, which could curtail the spending power and adversely affect the growth of the economy. And slow economic growth in turn would dampen the sentiment towards many a sector.However, in such times of uncertainty, it is always advisable to have a look at other investment opportunities and diversify investments. Remember, diversification is always a good move! Now, here, the indication is not towards other investment avenues like bank fixed deposits or debt markets or bonds. The opportunity lies within the equity markets itself. The dividend stocks!

The dividends, on the very surface, seem unimpressive as dividends are calculated on the face value of the share. However, it is the dividend yield that matters. Dividend yield is calculated as a percentage of market price of that stock. Let us see this with an example.

Consider a stock X whose face value (FV) is Rs 10, current market price (CMP) is Rs 50 and the company declares a 50% dividend. The dividend here will be Rs 5 (50% of FV), and the dividend yield would be 10% (Rs 5 as percentage of CMP). Compare this 10% return to a fixed deposit return of about 6% and the advantage of a high dividend yield stock is clearly visible.

Moreover, there are expectations that the FM may do away with the tax on dividends. If this happens, then dividend stocks could once again play a key role in one’s investment spectrum. However, one small negative, which would follow the acceptance of the proposal, is that the stock prices of high-yield dividend stocks would rise, which in turn would make the dividend yield fall. But the investors stand to gain in both the situations! If the stock prices surge, the gains would be in the form of capital appreciation. Otherwise, the investor continues to receive a steady flow of dividends from the company.

Worth a look...
Closing31-Jan-200131-Jan-200231-Jan-2003Capital AppreciationDividend**Total Returns
BSE Sensex 4,326.7 3,311.0 3,250.4 -13.3%NANA
Dividend stocks      
PNB Gilts 21.4* 19.2 22.8 3.3%4.212.3%
Tata Chemicals 54.7 40.9 58.4 3.4%10.011.9%
LIC Housing Fin. 32.8 50.2 63.3 39.0%9.048.5%
Blue Star 34.0 50.0 75.0 48.5%12.060.0%
Index heavyweights      
Infosys 6,786.7 3,889.4 4,301.1 -20.4%30.0-20.1%
HLL 207.0 220.7 170.9 -9.1%8.5-6.9%
Reliance 384.2 299.6 275.3 -15.3%9.0-14.0%
*March 5, 2001
**Total dividend declared by the company in the 2 years under consideration
Note: Interim dividends not included

It can be seen from the table above that in the last 2 years, the Sensex has fallen at a compounded annual growth rate (CAGR) of 13%. With the sensex down, it is obvious that the three index stocks, i.e. Infosys, HLL and Reliance, have also lost market capitalization. Infosys lost 20%, HLL lost 9% whereas Reliance lost 15% (CAGR). However, the 4 dividend stocks chosen here, have given positive capital returns (on CAGR basis) ranging from 3% to 49%! And the returns are higher (12% to 60%) if the dividends announced, in the 2 years under consideration, are added to the stock price. Though the 4 stocks that we have chosen do not sound glamorous, they have in the past, silently rewarded investors.

From the investors’ point of view, the ‘total return’ on the stock is more appropriate as compared to only the ‘capital appreciation’. After a company declares dividend, the stock goes ex-dividend i.e. the stock price tends to fall by as much as the dividend declared. This is because the dividend is declared from the companies’ profits and thus reduces reserves. Healthy dividend declarations are a good sign indicating that the company believes in sharing profits with the investors. However, the negative implication of healthy dividends could be that the company is unable to find suitable opportunities within the company or outside, where the money could have been invested for better returns.

Stability or Volatility…
 31-Dec-200231-Jan-2003Capital AppreciationDividend Yield*
BSE Sensex 3,377.3 3,250.4 -3.8%NA
Dividend stocks
PNB Gilts 24.2 22.8 -5.6%9.2%
Tata Chemicals 58.2 58.4 0.4%8.6%
LIC Housing Finance 64.3 63.3 -1.6%7.1%
Blue Star 74.5 75.0 0.7%8.0%
Index heavyweights
Infosys 4,771.2 4,301.1 -9.9%0.3%
HLL 181.8 170.9 -6.0%2.5%
Reliance 297.7 275.3 -7.5%1.6%
*Avg. dividend last 2 years
*Yield as on January 31, 2003.

Dividend stocks tend to be more stable vis-à-vis the markets. Of course, the chances of capital appreciation (or depreciation) are always there. But considerable fall in prices is unlikely compared to the so-called ICE stocks or other market fancy stocks. Basically, during times of falling markets, the dividend yields of these stocks become very attractive. As a result of this, the downside in these stocks is limited until and unless there is something seriously wrong with the fundamentals of the company. Moreover, these stocks also tend to appreciate with the general markets, though the rise may not be very spectacular. So, dividend stocks are for investors who prefer a steady income with a possibility of capital appreciation.

However, investing in a dividend story is not just about the dividend yield of the stock. It is also about the company, its management, the business model and fundamentals of the company. The dividend history of the stock is a good indicator of future dividend declarations by the company. However, there is always the likelihood that the dividend declaration trend might not continue or dividends may be curtailed down. Liquidity constraints could also be a dampener for these stocks.

Top 20 dividend payers in FY02

To sum it up, due to the continuing uncertainty facing the capital markets and the softer interest rate regime, high dividend yield stocks could give investors the best of both worlds.

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