Till the dividends come home
by Haresh Soneji/ Economic Times
The dividend yield ratio is computed by dividing the annual dividend per share with the current stock price of the company. So, if the annual dividend yield is around 10%, it means that you get Rs 10 on every Rs 100 you spend buying the stock.
This implies that as the stock price rises, its dividend yield declines and the same stands true the other way round too. So, at this point in time, as share prices seem to be moving largely up, dividend yield is on its way down.
In a falling market, however, shares of dividend-paying companies become attractive in terms of dividend yield. These stocks are likely to outperform the market when things don’t look great in the equity market. And the good news is that a surprising number of companies in India have been consistent dividend payers even through in times when equity markets are bearish.
So, a small retail investor with a low risk profile can enter into companies with a high dividend yield ratio. Small retail investors, who are primarily long-term players, value high dividend yields. These investors bite this bait as nothing could be a more credible way of knowing a company’s position than to see it give dividend cheques to shareholders. In India, the dividend yield of leading stocks has fallen over the past three years because of the continued bull run.
Dividend yield, per se, is not a useful investment tool. At best, it could help identify a set of stocks from which one could pick and choose. So, buying into a company based purely on the dividend yield ratio may be futile. Strong cash flows are the key. The ideal dividend payer is a company in a net cash position operating a business that does not need a lot of capital reinvestment.
While profits can be cooked up, sales vouchers fudged, dividend cheques have to be paid. No wonder, the 100-year quote of John D Rockefeller, one of America’s richest men, echoes the sentiment even today. He said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”
Also, taking a call on whether to buy or not depends much on the investment horizon as it is about the nature of business and the company’s business model. But, picking a good dividend stock isn’t only about the yield. Investors need to take into account the growth prospects of the business, the overall investment environment and the potential movements of the share price. The ideal combination is a stock that pays dividends and is also seen as a growth play.
During uncertain economic times, steady payers can rise rapidly in price, trimming dividend yields. Investors typically seek shelter in utilities, for example, in a bear market.
The most consistent dividend payers, despite being historically stable companies, are still subject to the vagaries of the market, especially if they operate in volatile economies. They are not nearly as risk-free as bank deposits. The prudent approach is to construct a diversified portfolio, with dividend payers at the core and growth stocks, bonds and cash deposits at the periphery.
