Buy Quality Dividend Stocks!

Equity markets can be one of the toughest markets to survive when there is an economic slowdown. The current slowdown has pushed a majority of the stocks southward anywhere between 15 per cent for quality stocks to 70 per cent or even more for some poor quality companies. The economic slowdown periods are known to test the best of investors' patience and all investors have got to do in such situations is to control their urges and focus on safety.




Just like in cricket, to win a test match on a difficult batting pitch, you need a batsman with an immaculate batting technique who is also solid in ‘defence’, during tough market conditions marred by slowing economy, investors need to have a defensive stance in the market. One of the best ways to have a defensive stance is to buy defensive stocks and/or buy stocks that pay dividends regularly. Even better for investors could be to identify quality dividend paying stocks in the defensive sectors such as IT, pharma and FMCG. This strategy may not only protect investors in the downturn, but it will also support the portfolio returns when the market enthuses investors with an upturn like it always does in the long run.

Says Amit Challani, a long term investor who prefers to accumulate dividend paying stocks, “In times of correction, the best thing that any investor can do is buy quality stocks with higher dividend yield. During correction, what happens is that the stock prices are cheaper by let’s say 20 to 30 per cent or even 40 per cent at times. All I do is increase my holdings in quality stocks that have a track record of healthy dividend distribution. We get stocks at 20 to 40 per cent cheaper cost and, over the years, the dividend yield becomes really attractive, so much so that it beats fixed deposit returns easily. I am holding on Ashok Leyland for the last 15 years. My purchase cost was close to Rs.7 per share. Today the dividend per share that I receive is little higher than Rs.3 per share. The dividend yield I am enjoying is close to 40 per cent now. Of course, the dividend yield is highest today at 40 per cent (after holding the stock for 15 years) and it increases as the dividend per share grows along with the growth of the company. Another share that I purchased for a little over Rs.5 per share in June 2009 was R Systems International Ltd. The company declared dividends to the tune of Rs.5.85 per share in CY2014 alone and another Rs.4.9 per share in CY2015. This company has not been consistent in distributing dividends, but I am happy with the dividends I have collected so far and the dividend yield is better than the fixed deposit rates for me.” 

It is important to consider dividends while calculating returns. Says Ritesh Ashar – Chief Strategy Office (CSO), KIFS TradeCapital Pvt. Ltd, "Investors must focus on total returns and total returns = Dividends plus capital appreciation.

Researcher Morningstar Inc. calculates that dividends were responsible for 19% of the S&P 500 index’s return over the past five years.

Owning a quality stock that distributes dividend regularly can be a boon to the portfolio in the long term. Here, investors must understand the yield, i.e dividend yield really gets exciting as years pass by. Hence, the dividend game is for ultra long term investors and not for investors who are building portfolio with an investment horizon of one year or even three years.

There is always an investment case where the share prices have fallen and the company is maintaining its dividend payout ratio. All investors have to do is to observe where the low hanging fruits are. Market correction is a huge opportunity for dividend investors.



If we consider the TOP 50 biggest wealth creators in the last 15 YEARS for the Indian markets, we find that almost all of the stocks pay regular dividends. Also, it must be noted that, on an average, these set of wealth creators have distributed dividends in 13 YEARS out of 15 YEARS. This reflects the consistency with which the multi-baggers have distributed dividends. Not all dividend paying stocks are multi-baggers, but majority of the multi-baggers are consistent dividend payers.

The table above showcase how the dividend yield has increased for several companies post market correction. For some companies the dividend yield has jumped to 12 odd per cent from 2.5 per cent. This increase in dividend yield is ofcourse due to heavy correction in stock prices. Some of the quality names such as Vedanta and Care ratings also feature in the list of stocks where the dividend yield has increased owing to stock price correction. In some cases the divided yield has also increased due to increase in dividend payout. Ashok Leyland is one stock where there is increase in dividend payout even as the stock has corrected by almost 50 per cent in one year's time. The combination of both is making the dividend yield look very attractive.

But is it a good sign and should one simply buy those stocks where the dividend yield has increased sharply? What is the guarantee that such high dividends will be sustained by companies?

Don’t be fooled into high dividend yielding stocks

On the one hand, high dividends look attractive, but when one studies deeper, it is easy to realise that higher dividend yield stocks are not always good for long term investments. A dividend yield of 3 to 4 per cent is fine, but any stock with a dividend yield higher than let’s say 6 to 7 per cent should be analysed with a lot of scepticism. Such above average dividend yield could be due to falling earnings and overall deterioration in the fundamentals. Also, the fact that the company is distributing huge chunk of its cash to shareholders highlights the lack of investing opportunity for the company, indicating growth hurdles in the future. There are instances in the corporate world where we have seen corporates borrowing money just to maintain their higher dividend payouts. Clearly, such companies should not feature in long term investment portfolios.

If we consider the top 20 BEST performers (returns) of BSE 500 INDEX for a period of 5 YEARS, we find out that out of the top 20 STOCKS, 11 STOCKS have been consistently distributing dividends and there is growth in dividends over a period of five years, along with growth in earnings registered over the 5 YEARS. 

How to go about pursuing quality dividend yield stocks?

While dividends are good and stocks with higher dividend yields may look ‘cool’ superficially, the devil lies in details. Be sceptical of extremely high dividend yield stocks, especially those that are yielding close to 10 per cent. Caution is better than regret. If it is not that straightforward to choose a dividend yield stock in the sense that higher dividend yield does not always turn out to be good investments, how should investors then build a portfolio with high dividend yield stocks?

One of the best ways to identify a good quality stock with dividends is to study the history of dividend payouts. Ideally, those stocks with a history of dividend increases are perfect for investments. The increasing dividends or the growth in dividend per share (DPS) can be considered as a sign of financial strength. There is enough research available which indicates that the companies that initiate or increase their dividend consistently outperform not only other dividend paying stocks, but also key benchmark indices. The point to be noted here is that those companies which initiate dividends (paying dividends for the first time) are to be observed keenly as well. Some of these stocks include HDFC Life Insurance and ICICI Securities.

One may ask if it is sufficient to identify stocks that distribute dividends consistently and is it good enough to simply calculate the dividend growth in the underlying stock and invest in it? The answer obviously is NO. One also has to check for earnings growth along with with dividend growth to make a solid case for investing.

From 1958 through 2018, a portfolio with the top 20% of S&P 500 companies ranked by dividend yield and weighted by market capitalisation outperformed the overall S&P 500 by 2.13 percentage points annually, according to Chicagobased Greenrock Research.

In other words, we can say that investors can do themselves great service if they can find stocks that regularly pay dividends and whether the dividend is growing every year by a certain rate. However, the earnings should also reflect growth year-on-year. The results could be even better if we can identify stocks where consistently the earnings growth has been higher than the dividend growth as in the case of Bajaj Finserv.

The table below highlights the performance of companies that are constituents of BSE 500 and reflect consistent dividend payout behaviour (5 years consistent dividend payout), dividend growth and earnings growth. We find that there are almost 160 companies in the BSE 500 basket that have shown growth in dividends and earnings over the five years. Almost 85 per cent of these 160 companies, i.e 136 companies, have managed to generate positive returns. On an average, these 136 companies generated 17 per cent CAGR return over a five-year period. The BSE 500 has delivered 7 per cent CAGR return in similar period. 

Table : Performance of BSE 500 constituents (Top 20) qualifying on regular dividend payouts, dividend growth and earnings growth parameters.



What is Sensex dividend yield telling us?

Sensex has corrected close to 9 per cent from its all-time high of 40000-odd level. With market correcting, the dividend yield for the Sensex has also risen. For July 2019, the dividend yield for Sensex was 1.230 per cent p.a., higher than 1.190 per cent p.a. in June 2019. The average dividend yield for Sensex if we consider the data from December 1996 to July 2019 is 1.425 per cent. This suggests that the current dividend yield for Sensex is higher than the average dividend yield it has displayed since December 1996. The dividend yield reached its all-time high of 2.460 per cent p.a. in August 2002. The record low dividend yield for Sensex was 0.830 per cent p.a. in December 2007. 



"Do you know the only thing that gives me pleasure? It's to see my dividends coming in"

John D. Rockefeller

The Sensex dividend yield is telling us that the stock prices are getting cheaper and that the dividend yield is getting little more attractive for investors to take equities seriously.

Conclusion

Dividend stocks may not be as glamorous as high growth stocks for many, but quality dividend stocks definitely have a potential to generate regular income in the form of dividends. This ability makes the difference during periods of economic, market and political uncertainties. When it comes to playing defence, quality dividend stock is what one should be looking at. In a world of slow economic growth and geopolitical uncertainty, investors have to find ways to generate returns. There can be no better way than to collect dividends from quality stocks. The beauty about quality dividend stocks is that they tend to outperform majority of the stocks in the markets and hence the potential for capital gains is high in the longer run.

If you are one of those investors who believe in risk-adjusted returns, quality dividend paying stocks show relatively less volatility than stocks that do not pay dividends. Also, investors can take a lot of comfort from the fact that the dividend paying stocks often have strong balance sheets. This financial strength in quality dividend paying stocks ensures that the company survives a slowdown with far less damage than its peers. In the long run, it does make a remarkable difference to the investor’s portfolio.

Globally, there is a trend of reducing interest rates. The neutral stance adopted by western economies hints at fears of slowing global economy. In India too, as the interest rates slide lower, the dividend paying stocks start looking more attractive. One must realise that dividends are inherently relatively stable and form an important part of total returns. In the current market situation, where a majority of the stocks have corrected heavily, dividend yield for some of these quality stocks has improved substantially. All investors have to do is identify the quality stocks and start accumulating these stocks which not only distribute dividends consistently, but also reflect growth in dividends and earnings. All said and done, the focus should also be on the quality of management and corporate governance standards, as these are some of the most sensitive issues impacting stock prices these days!