A near-10 per cent correction in the market has made many stocks attractive for a dividend play. When markets fall and no one knows where the bottom rests, investors characteristically look for safer bets in which the returns could be at least fair, if not stupendous as in a bull phase.
Unfortunately, the Indian market is in such a phase. Though the market has corrected more than 9 per cent from its end-January peak, many experts believe the worst is not yet over and there could be more downside to stocks.
In such a settings, a low-risk and doable thing for investors would be to check out dividend yield stocks for a steady income and a stable portfolio.
“As long as you hold the stock concerned and as long as the company continues to pay dividends at the same rate, your dividend yield is fixed for life, even if the market price of the stock changes subsequently. Other things being equal, the yield will be higher if you buy the stocks at a lower price,” says VK Sharma, head private client group & capital market strategy, HDFC Securities.
“When you are not sure how long the correction will last, a good dividend yield will give you a steady income and, therefore, you can afford to forget what the index or the stock is quoting at. You treat the stock more like a fixed deposit where you get your fixed returns. Therefore, you have less tension,” explains Sharma.
What makes these investment more attractive is that dividend is tax-free. By current rules, dividend is tax-free in the hands of investors to the extent of Rs 10 lakh a year. This is a huge benefit. Even if one earns more than Rs 10 lakh as dividend, the tax rate is only 10 per cent on the rest compared to 30 per cent otherwise, excluding cess and surcharges. Moreover, it is even less than the short-term capital gains tax of 15 per cent and is equal to the long-term capital gains tax of 10 per cent.
If, for instance, one earns Rs 15 lakh as dividend income in a year, out of this Rs 10 lakh is exempt from income tax. For the remaining Rs 5 lakh, one pays a tax of just Rs 50,000, that is, 10 per cent tax.
The tax savings alone make returns attractive for dividend stocks. Any dividend eanred over and above these solid savings can be taken as icing on the cake.
“Of the various value-investing strategies, the dividend yield strategy is the most suitable now, because most companies have already either declared their final dividends or are in the process of doing so. Bear in mind, though, that the dividend yield varies with the market conditions. In a bear market, a yield of 5-6 per cent can be considered good while in a bull market, like the one we are in, the dividend yield should be at least 2-3 per cent,” says Gaurav Jain, director, Hem Securities.
Dividend yield can be arrived at by dividing the dividend per share for the full year with the purchase price of the stock and then multiplying the outcome with 100.
But the dividend yield strategy cannot be a blind game, cautions Jain. “Even as everyone fancies hefty dividend payouts, investors need to keep several factors in mind when playing the dividend yield strategy. Very often, the share price corrects after the dividend payout, thus, limiting the chances of any real gain from dividend stripping—selling the stock just after you receive the dividend. We suggest that investors should hold these shares for the long-term and not treat dividend yield strategy as a short-term play.”
Also, before one jumps to buy a stock, full attention should be paid to the following points.
First, the company's track record in paying dividends has to be seen. Does it pay dividends regularly? Is there a noticeable pattern of, say, steady dividends, or increasing dividends? If the answers are yes, that would make one's decision-making easy.
Second, investors have to do some crystal gazing and figure out whether the company will be able to maintain the dividend, especially in times of falling profits?
Third, look at the payout ratio. If a company pays out a higher percentage of profits as dividends in select years, then it is more susceptible to a dividend shrinkage should things go wrong in the future. Also, if there is a consistent high payout and the dividend is rising then there is a good chance that the stock may have a higher price-earnings ratio (high stock price) and a lower dividend yield and it may not even figure in your short-listed stocks.
Anita Gandhi, whole time director at Arihant Capital Markets, said: “When markets become very expensive, the possibility of further capital appreciation from the stocks reduces substantially. Also, if an investor invests when the markets are very expensive, chances of losing the capital are higher, if the investor is looking for the short-term. At such times, conservative investors can ideally look at high dividend yield stocks. There are a few companies that offer dividend yield higher than bank fixed deposit interest rates. IOC, Hindustan Zinc, HPCL, BPCL, REC, PFC, Coal India and NHPC have given dividend yield above 6 per cent based on dividends given during 2017-18. The majority of these companies are PSUs or commodity companies. These companies generally enjoy lower PE multiples. These lower valuations also helps in a higher dividend yield ratio. On the flip side, generally one cannot expect very high capital appreciation from such companies. However, these companies have good positive cash flow and steady businesses”.
Having government as a shareholder reduces the risk of a company lowering its dividend rates. In companies like Coal India, in which the government holds a 78 per cent stake, the Centre is interested in getting the maximum dividend out of the company to manage the fiscal deficit well. In some years, Coal Inda even had to dip into its reserves to a pay higher dividend to the government.
But state-owned companies are a double-edged sword. If the government comes out with an offer for sale to reduce its holdings, this can keep the stock subdued for some time. On the other hand, a strategic sale in a PSU can lead to instant capital appreciation for the investor.
Short-term opportunities are also there in dividend strategies. Most companies have March as the year-end. They will have their shareholders meetings (AGM) in June-July and dividends may go out by July-August. So dividends should come by September. That means, full six months down the line, a stock that gives one an 8 per cent dividend yield may actually mean 16 per cent on an annualised basis, assuming the price remains the same for one to exit the stock at the same cost.
Pritam Deuskar, fund manager, Bonanza Port- folio, says, “One should look for a yield above 5 per cent as average dividend yield over the last four-five years. So, when such share price comes down where yields are attractive, investors can buy them before the record date of dividends. Some names in this category are NMDC, HPCL and Coal India. Also, do note that these PSUs may not be that attractive in terms of share price appreciation. So with good dividend some small share gives you a good opportunity over a shorter span.”
Whether the startegy is short-term or long-term, it is always good to have an exit strategy in place. “When a stock gives you three times its dividend yield in terms of capital appreciation, go back and ask your relationship manager to evaluate the stock for you and take his view whether to hold or sell,” Sharma of HDFC Securities said.
Though the stocks that give high dividend yields are not always the best of investments in times of growth, since one holds them through a bear market for the comfort of dividend yield, one can have the benefit of capital appreciation in the next bull market. That makes dividend yield a desirable investment strategy.