Dividend Stocks to the Rescue

Volatile markets call for investors to be cautious. Market correction often leads to investors rethinking their original portfolio strategy and asset allocation. Deep market corrections also lead us to focus on the safety net of high dividend-yielding stocks. Yogesh Supekar discusses the importance of having high dividend-yielding stocks in the portfolio while also highlighting the emerging opportunities in the market owing to steep correction 

The market correction this time around has surprised the bulls even as the optimistic bears eye further downsides. While several economists and market analysts speculate a recessionary period for the economy and hence a bear market for equities, investors have started to seriously rethink their portfolio strategy biased towards growth stocks. Time and again we have seen that higher inflationary periods and rising interest rates impact most negatively the growth stocks. In the past few years, we have evidence of investors lapping up on growth stocks and ignoring value stocks. 

However, the trend of growth investing seems to be taking a huge hit in the course of the recent market correction as is evidenced by the drop in NASDAQ and IT stocks in the Indian markets. The preference for value stocks amongst portfolio managers is discussed in investing circles. Here is where the dividend-yielding stocks come into play. High dividend paying stocks are considered to have some embedded value not only because of their ability to pay dividends consistently but due to stability in earnings. 

It is not unusual to see a fall in stock prices getting arrested owing to the high dividend yield that a stock has on offer. There is high probability of investors chasing high-dividend yield stocks in market downturns and hence the buying can emerge earlier in high-quality dividend-yielding stocks than the hot and most popular growth stocks. So, why prefer dividendyielding stocks over non-dividend-yielding stocks? The basic requirement before choosing any stock for investing is to verify if the fundamentals of the stock under consideration are good. A consistent dividend pay-out supports the story of strong fundamentals for the stock and hence it instantly becomes appealing for investors who are willing to buy and hold for the long term. 

For starters, a consistent track record of dividend pay-out supports the fundamentals; however, one should deep dive into the fundamentals before buying a stock based only on its attractive dividend-paying capacity. One of the most important arguments in favour of the high-quality dividend-yielding stocks is that the earnings’ volatility is minimal in such kind of stocks. Thus, the risk-return trade-off becomes favourable when one chooses to invest in high-quality dividend-yielding stocks. 

A simple macro understanding of what drives stock prices will help us understand the attractiveness of high dividend paying stocks. Small-caps are considered risky because they are more volatile than the Mid-Caps and large caps. The stock prices of the small-caps are usually extremely volatile because their earnings are more volatile than Large-Caps and mid-caps. Thus, the risk-adjusted returns are compromised in case of such highly volatile small-caps or even mid-caps for that matter. 

With dividend-paying stocks the earnings’ volatility issue is already addressed. However, this applies to only those stocks which have a consistent track record. High dividend-paying stocks are usually less volatile and low beta stocks. The draw-downs in case of high dividend-paying stocks are also lower compared to the non-dividend-paying stocks. The table below highlights the low beta characteristics of high dividendpaying stocks.

Another important advantage while choosing dividend stocks over non-dividend-paying stocks is valuation. The high dividend-paying stocks are often matured businesses and do not fall in the growth category of stocks. As the businesses are matured for dividend-yielding stocks with predictable cash flows, the valuations often are not very expensive. The PE multiples will almost always be reasonable when compared with growth stocks. In fact, during market corrections the PE multiples get depressed and there is always an opportunity to hand-pick high-quality dividend-yielding stocks at depressed prices and enhance the dividend yield of the overall portfolio. Ideally, high dividend-yielding stocks with healthy RoE of closer to 20, lower DE ratio and healthy profit margins are the most suitable candidates for portfolio inclusion. 

Says Chetan Tupe, a long-term investor who prefers to buy dividend-yielding stocks: “For me dividend is the key as I have always planned to make a living on the dividend income. I have been investing in equities since 2002. However, I started showing preference for dividend stocks only by 2006-2007. One of my most rewarding high dividend-paying portfolio stocks has been R Systems. I bought it in 2007 for ₹ 13.50 per share. The stock did not do much for the next 4-5 years in terms of share price appreciation; however, the company declared dividends on regular basis and that kept me glued to the stock. Despite minor share price correction, I continued to remain invested in the stock. I am still holding it.” 

“The stock is trading at ₹ 200+ per share but the most satisfying aspect of holding R Systems since 2007 is the amount of dividends I have accumulated over the years. My rough calculations suggest that I have garnered ₹ 66.85 in terms of dividends per share while my purchase price has been less than ₹ 14 per share. That means my money has grown five times in the form of dividends alone and the price appreciation in the share price is a bonus. Any dividend investor has to have loads of patience and needs to be a long-term investor with a clear goal of accumulating dividends. In the long term true wealth can be created by holding on to high quality dividend-yielding stocks. The results are extremely rewarding and financially satisfying. I know a few investors who have sponsored their children’s education in foreign universities from the dividends received. A portfolio of high-quality dividend-yielding stocks is a sure-shot way to prosperity in the long run,” he adds. 

"The true investor... will do better if he forgets about the stock market and pays attention to his dividend returns and to the operation results of his companies".
- Benjamin Graham 

Understanding Dividend Yield and its Calculation 

Dividends are the surplus cash that the company gives to its shareholders on monthly, quarterly or yearly basis depending on its performance. Dividendpaying stocks are very popular with investors because they provide a regular, steady stream of income. Companies that experience big cash flows and don’t need to reinvest their money are the ones that normally pay out dividends to their investors. A corporation with a high dividend yield pays out a large portion of its profits as dividends. The dividend yield is calculated using the following formula:

Dividend yield = Annual dividends per share / per share market price * 100. 

Assume a company with a stock price of ₹ 100 declares a dividend of ₹ 10 per share. In that case, the dividend yield on the stock will be 10/100*100 = 10 per cent. High dividend yield stocks are attractive investment choices during volatile times since they offer flexible payment alternatives. They are appropriate for investors who are risk-hesitant. Investors should keep in mind the need to research the company’s price and dividend-paying history. Companies with a high dividend yield typically do not keep a big portion of their earnings as retained earnings. On the other hand, growth stocks preserve a big portion of profit in the form of retained earnings and use it to expand the business. 

Dividends are tax-free in the hands of investors. Thus, buying high dividend-yielding stocks can help you save money on taxes. Investors frequently utilise dividend stripping to save money on taxes. In this process, investors acquire stocks before the dividend is declared and sell them after the payout. This allows them to get tax-free dividends. The share price normally lowers after a dividend is paid. When an investor sells a stock after the dividend is paid out, he incurs a capital loss that can be adjusted against capital gains. 

Power of Dividends 

Vedanta recently announced dividend of ₹ 31.5 per share. Since October 2020 it has declared dividends of ₹ 9.5 + ₹ 18.5 + ₹ 13.5 + ₹ 13 + ₹ 31.5 = ₹ 86 per share. It is interesting to note that any investor who bought Vedanta around the pandemic lows has got all the money back and still has a stock worth ₹ 300. On April 3, 2020, the shares of Vedanta closed at ₹ 63 per share. 

Market Outlook

If tactically the markets were looking overbought in February, today the market is clearly in an oversold position. There may be enough room for the markets to go higher from the current level and hence it is possible that institutional investors may go overweight on Indian equities. Outside US the global equities are now trading at 12.6 times the forward earnings. There are signs that inflation may have peaked and hence recovery can be expected from the current levels. Even the resurgence of the pandemic in China is showing signs of normalising. A bull case scenario for equities cannot be ruled out if one believes inflation is falling and the fears of recession are overblown. The second half of the year 2022 promises to be a much better period for the global equity investor.

MSCI India High Dividend Yield Index (INR)



The MSCI India High Dividend Yield Index is based on the MSCI India Index, its parent index, and includes large and mid cap stocks. The index is designed to reflect the performance of equities in the parent index (excluding REITs) with higher dividend income and quality characteristics than average dividend yields that are both sustainable and persistent. The below graph indicates the outperformance of high divided yielding stocks.

Conclusion

It is always a rewarding experience when some of your portfolio holdings declare dividends. Apart from improving the portfolio performance marginally and providing tax-efficient cash flows, the highquality dividend-yielding stocks have proven to be true wealth-creators. The advantages are tacit when it comes to investing in high-quality dividendyielding stocks and hence should be part of any portfolio, be it an aggressive portfolio or a conservative one. To increase the utility and contribution of the high dividend-yielding stocks one can combine the use of market timing skills along with fundamental analysis. 

Market timing skills when applied for choosing high dividedyielding stocks can help investors magnify the returns. Buying across the board high dividend-yielding stocks when the market goes through a correction is a tactical portfolio strategy that can help improve the overall portfolio performance by a good margin. Knowledge of technical analysis can come handy in choosing such high-quality dividend stocks when they are in oversold condition. The idea is always to buy a high-quality dividend-yielding stock at the right or discounted price. Market correction provides investors an opportunity to buy cheap and such opportunities should not be missed by a long-term investor who aims to beat the markets while taking minimal risks. 

"I do not own a single security anywhere that doesn't pay a dividend, and I formed a mutual-fund company with that very simple philosophy." - Kevin O'Leary 

One of the smart ways to play on high dividend-yielding strategy is also to not ignore the sectoral trends. Portfolio performance can improve drastically if high-quality dividendpaying stocks from those sectors that are witnessing above average growth trends can be preferred. For example, we have so far seen a good number of high dividend-yielding stocks coming out of the FMCG sector. However, owing to inflationary pressure, the consumption trend is weak and the rising raw material prices are impacting the profit margins of the FMCG companies negatively. Thus, it may be better to focus more on high-quality dividend-yielding stocks from the power sector at this point of time rather than stocks from the FMCG sector. 

There is huge amount of pessimism in the markets at this point of time which may support value investors and hurt growth investors. We have also seen that value stocks have not participated in the current bull market. Thus, value stocks could be at an early stage of a bull run. Technically speaking, the market is in an oversold position and we may witness a recovery in stock prices in the coming few months. The best way to participate in the markets should be to focus on value stocks as global investors dump growth stocks and move some cash to value stocks. There is lot of value in several counters with steady cash flows and high dividend yields as the market corrects. To be objective, value stocks with high dividend yield may outperform markets in the near to medium term.