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The dividend attraction

Apr 5, 2001

The stock markets in recent months have been a big disappointment for investors. Across the board selling pressure has led to erosion in capital of billions of investors. The losses have been significant. In such a scenario, does it make sense to risk investing in stocks again?Maybe. Look at it this way. Returns from a stock comprise of two components – dividend and capital gains. It is the latter that generates most of the attention revolving around stocks. The first, that is the dividend, has generally been ignored.

Consider this. The return on one-year government paper is under 10% (tax free). On the other hand, there are several stocks that have a dividend yield in excess of 10% (tax free). There is a case for investors to put money in such stocks. What we have attempted to do below is highlight a few such stocks, which at current prices offer attractive dividend yields.

A note of caution is needed here. It is not necessary that companies paying high dividend only make investment sense. It is possible that the company prefers to invest the money in a new plant; launch of a new product line or it could be for making acquisitions of brands or companies having same synergies. The management might be doing much more to build shareholder value than it would have been doing just by passing their earnings as dividend. A prudent and efficient management would not increase the payout ratio by scarifying opportunities for reinvesting increased earnings in the business. The best example is the companies in the software sector, which have relatively low dividend payout ratio.

Nevertheless, the fact remains that an increase in dividend rate is invariably looked upon as a ‘favourable’ development.

The following table indicates that the stocks, which have been hit by the markets, are showing high dividend yield. These stocks are not from the much talked about TMT, pharma or FMCG sectors. These stocks are trading at a significant discount to their expected performance in the coming years. Out of the 22 companies selected for the study, 8 are from the finance sector. Banking stocks are losing ground on the recent co-operative bank default and bullion trading scam. However, these banks are fundamentally sound and the only risk is to the extent their profits will be eroded (a one time write off) on account of having to make provisions for the losses.

Scrips like Pentamedia Graphics has been hit due to the adverse perception of the management notwithstanding the fact that the company is the leader in animation industry.

Dividend yield analysis
Tax free
Electrosteel Castings15.0100.015.0%21.6%
Madura Coats1.812.014.6%21.0%
Thirumalai Chemicals4.028.014.3%20.6%
Tata Chemicals5.039.912.5%18.1%
Supreme Industries7.057.012.3%17.7%
Pentamedia Graphics10.083.012.0%17.4%
Tata Finance4.538.911.6%16.7%
Chennai Petroleum3.029.410.2%14.7%
Centurion Bank1.010.29.8%14.1%
Bank of India1.010.59.5%13.7%
Indusind Bank1.313.89.1%13.1%
Oriental Bank of Commerce3.540.08.8%12.6%
Global Trust Bank2.225.28.7%12.6%
BPL Ltd.
Bank of Baroda4.056.07.1%10.3%

However, while using this investment approach investors need to determine the consistency of the company in paying dividend. Let’s say for example the dividend yield of a company amounts to 15% this year, but due to adverse business developments it is unable to pay dividend in the coming year. In such a scenario, of course, the investment would be a disappointment. So one needs to pick a stock where there is a high probability of a consistent payout.

The dividend considerations should not be given an unduly high weightage by those desiring to select outstanding stocks over the long term. Some stocks would compensate the low dividend yield by generating higher capital appreciation.

In a bottom finding market dividend yield could help investors protect their returns vis-à-vis debt portfolio. At the same time allowing the investor to benefit from any upswing in the markets.

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