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Why share prices will no longer matter? - Views on News from Equitymaster

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Why share prices will no longer matter?

Mar 2, 2009

Does your heart skip a heartbeat everytime the BSE-Sensex plunges 500 points in a single day? Do you lose sleep over the fact that your portfolio is down a huge 50%-60% from a year ago levels? If your answer to the above mentioned question is yes, then perhaps the table below will help you to get rid of your stress levels and anxiety for good.


   Dividend yield (%)
  3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0
5% 24.718.814.010.07.05.02.00.0
6%20.715.7 11.9 8.8 6.13.81.80.0
7%17.8 13.5 10.2 7.6 5.33.3 1.60.0
8%15.611.9 9.0 6.64.6 2.91.40.0
9%14.010.68.0 5.94.12.61.20.0
10%12.6 9.6 7.3 5.43.72.31.10.0
11% 11.58.8 6.64.9 3.42.11.00.0
12%10.6 8.1 6.14.53.1 2.00.90.0
13%9.9 7.55.74.22.9 1.80.90.0
14%9.2 7.0 5.33.92.71.70.80.0
15% 8.66.65.03.7 2.6 1.60.80.0

There are two major ways in which an investor in stocks can profit from his investments. First is of course through stock price appreciation, which we know can remain depressed for years even if the fundamentals of the underlying company are good enough. Another way to profit from an investment in a stock is through dividends. And dividends unlike stock prices, do not depend on the whims and the fancies of the investor community at large. If the business is performing well and generating cash in excess of what is required for growth, dividends will be paid out irrespective of the stock price movement.

Thus, total return that accrues to an investor is the aggregate of the returns that he earns from the movement in stock price and the yield that he earns from dividends. Let us take an example to clarify things further. If the stock is priced at Rs 100 and its stock appreciates by 5% during a year and also pays a dividend of Rs 5, then the total return would turn out to be 10%, 5% through stock price appreciation and 5% by way of dividend yield.

Since stock prices can be quite whimsical, wouldn't it be great if most of the returns accrue to an investor by way of dividends. In fact, how about having no dependence on stock prices at all and getting one's returns completely from dividends. Is that possible? We believe it is well within the realms of possibility. And this is where the above table will help you in your endeavor.

The above table has dividend yield on one side and the dividend growth per annum on the other. And all the other numbers that make up the table are nothing but the number of years. In other words, if an investor desires a 10% return from dividends alone then at a given dividend yield and dividend growth rate, the number of years in which the goal will be achieved is laid out in the above table. The shaded area of the table is nothing but the different scenarios where the goal of 10% annual return from dividends will be achieved in five or less than five years. Say for e.g. if the dividend yield of a stock is 6% then the dividend per share has to grow at a rate of at least 11% for the goal of 10% returns from dividends alone to be achieved in less than five years.

It should be noted that after the goal has been achieved, even if the dividends per share of the company remains constant, the investor is assured of 10% return on his original investment price. Hence, the trick is to invest in a company that is likely to have little or no capex as well as working capital needs so that dividends per share is maintained after a period of few odd years of growth in dividends per share.

Besides helping one out in having a clear assessment of the timeline required, the table also highlights the peril of investing in a stock where a dividend yield is on the lower side. As seen from the table, if one invests in a company with a dividend yield of barely 3%, even with a 15% annual growth rate in dividends per share, it will take as many as close to 9 years to achieve the desired result of a 10% return from dividends alone. Thus, dividend yield can also be used as a good yardstick in examining whether the stock is priced cheap or not.

The legendary Warren Buffett is believed to have once said that he looks to invests in those companies where even if the stock markets are closed for five years, it will not matter to him. Perhaps, he was referring to the same idea that if one invests in a company at levels where the current dividend yield and growth per annum in dividends per share is so attractive that within few years, the returns from dividend alone will amount to 10% or thereabouts, then the stock markets remain no longer relevant for one's investment success.


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