Sunday, July 3, 2016

Dividend investors miss the bus

Chasing high dividend yield stocks has led to meagre returns for Indian investors over the last 10 years. Here are the learnings
Fans of dividend yield investing have had a tough time in the Indian markets over the last 10 years. Of the six equity funds dedicated to dividend yield investing, only one has made it to the top quartile in the multi-cap category.
Those who bought the top dividend yield stocks of Nifty have seen their portfolios fail to beat the index in five of the last 10 years.
Using dividend yield as the main criteria to select stocks for one’s long-term portfolio has led to many lost opportunities on wealth creation too.
A portfolio of the top 10 dividend yield stocks in the Nifty bought ten years ago would have generated negative annual returns of 0.1 per cent till date, while the index returned a 11 per cent annualised return (see table). Similar portfolio built five years ago has served up equally meagre results, with a 0.2 per cent annual return.
This is because investors focussed on high dividend yield would have packed their portfolios, over the last ten years, with public sector banks such as Andhra Bank, Allahabad Bank and PNB, cash-rich PSUs, such as Nalco and NMDC or commodity plays such as SAIL and Tata Steel, all of which have seen their prospects take a turn for the worse and stock prices take a battering in recent years. In case you’re wondering, the yearly dividends haven’t really compensated for the stock price losses. The total return on these stocks (total returns factor in both price returns and reinvested dividends) ranged from a negative 7 per cent to a negative 32 per cent over the 10-year period, while the Nifty earned a total return of 196 per cent.
Here are four learnings that we can take away from this experience.
Earnings matter more than dividends
A company may be a liberal dividend payer. But if its profits or prospects take a turn for the worse, this does take a toll on in its stock price returns. HCL Infosystems — a fancied dividend yield stock until three years ago —offers evidence of this.
HCL Infosystems was flying high on strong demand for its hardware solutions between FY-06 and FY-08, when the firm offered a high dividend yield of 5 to 6 per cent. But margin pressures and forex losses forced a 40 per cent drop in its net profits between FY-08 and FY-11. Though the company valiantly maintained a yield of 6 to 9 per cent throughout this period, the stock price fell all the way from ₹170 in early 2008 to ₹50 by end-2011. With the company forced into losses in the last three years, the dividends have disappeared. After factoring in dividends, investors have seen losses of 64 per cent on the stock over the last ten years, even as the Sensex has doubled.
PSU banks such as Corporation Bank (3.4 per cent dividend yield) and Andhra Bank (4.6 per cent) and Syndicate Bank (3 per cent yield) were top dogs on dividend yield barely five years ago. But with these banks hard-hit by asset quality problems, their profits have been on a slippery slope. Though they have maintained their payout ratios till date, their investors have made losses of anywhere between 28 per cent and 60 per cent on a total return basis, while the Sensex has gained 56 per cent in the same five years.
The above examples tell us that, when screening sectors or stocks for one’s long-term portfolio, a ‘total return’ approach delivers the best results. One can look for companies that have a liberal dividend policy, but not at the cost of earnings growth.
Dividends can be cyclical
One of the key assumptions in dividend yield investing is that the company with a high yield will sustain its current rates of dividend for the foreseeable future. But this assumption can be challenged in cyclical businesses.
The commodity price collapse of the last five years has shown that when profits are mercilessly squeezed in a downturn, belt tightening on dividends is inevitable. High dividend payers from the steel, metal and mining sectorshave effected drastic cuts in the subsequent five years.
Take Tata Steel, which kept up a stream of generous dividends at ₹16 per share from FY-06 to FY-09 as its profits soared on the back of the booming global steel cycle. But as the Chinese slowdown hit steel demand and prices, its dividends have slumped in the last four years, to ₹8 to ₹10 per share. Tata Steel’s ten-year total returns stand at a negative 7 per cent. Under increasing pressure from the Government to offload its cash pile, NMDC upped its dividend from ₹7 per share in FY-13 to nearly ₹11 in FY-16, even as its net profits halved. But the stock has dropped from ₹120 in October 2013 to ₹91 now, as iron ore prices went through the wringer. The stock’s total return for five years, at a negative 54 per cent is, again, far less than the market.
The above examples illustrate the pitfalls of focussing on a stock’s current dividend yield, without looking too deep into the sustainability of those dividends.
No safety net
When adversity strikes, the adage goes, high dividend yield offers a ‘safety net’ against investors dumping the stock. But this has been disproved in the last five years.
Investors scouting for high dividend yield in mid-2013 would have enthusiastically bought PNB, NMDC, BHEL and Cairn India (dividend yields of 4 to 6 per cent then).
But they would be rueing their choices now, as these stocks have completely missed out on the Modi rally.
While PNB’s earnings have been flattened by escalating bad loan problems, BHEL has suffered from shrinking order flows and Cairn India has been the victim of the oil meltdown. As a result, their stock prices have suffered losses ranging from 12 per cent to 52 per cent in the last three years, even as the Nifty has clocked a 30 per cent gain.
In short, if you are looking for less volatile returns or downside protection in equities, it is visibility and consistency of earnings that you should be looking for. If those factors are absent, dividend yield cannot come to your rescue.
A ‘Total Return’ approach
What these instances tell us is that chasing the highest dividend yield stocks in the market for one’s portfolio (whether for a year or a longer holding period) is fraught with risk. Ignoring the sector prospects or earnings outlook in the hunt for dividend yield often forces one to settle for poor total returns.
Instead, the stock selection strategy that works far better is one that focuses on earnings growth, even if it comes with a moderate dividend yield.
But are there actually companies that combine good growth with liberal dividends? Aren’t the two mutually exclusive? Analysing the dividend and stock price returns of the NSE-listed stocks for the last ten years, shows that there are a fair number of companies that have managed this combination.
With a dividend of about ₹3 per share (yield of 3 per cent) in FY-06, TTK Prestige is hardly likely to have attracted any dividend investor’s attention ten years ago (there were several stocks then offering a 5-6 per cent yield). But as the company scaled up rapidly in the consumer appliances space over the decade, its profits have vaulted and dividend payouts have risen nine-fold to ₹27 per share. With the stock turning a multi-bagger, the investor has earned total returns of over 47 per cent CAGR with a good portion of this coming from dividends.
Blue Dart Express, GSK Consumer, Eicher Motors are among other stocks which featured low dividend yield ten years ago, but have managed rising dividends in the last ten years. In all their cases, as steadily growing profits have enabled the company to hike dividend payouts, investors have made impressive total returns, raking in both dividends and stock price appreciation (see table). Some of the stocks in this list have, no doubt, received a lift from the wave in favour of growth-style investing in the last ten years. While value investing may well make a comeback in the next cycle, that doesn’t mean that Indian investors can go back to pure dividend yield investing.
The reason for this is simple. Investing in stocks with dividend yields of 2-3 per cent may make eminent sense in the US market where regular income is hard to come by and bank deposits offer barely 2-3 per cent a year. But in the Indian context, where you can easily make a 5-6 per cent post-tax return from risk-free investments, there’s little reason to risk capital losses in equities for a ‘high’ 3 to 4 per cent dividend yield.
Therefore, the next time you look to select dividend payers for your portfolio, don’t forget to take stock of the company’s earnings trajectory, return on equity and sector prospects. Also remember to look beyond the usual hunting grounds for dividend yield investors — the cash-rich companies, PSU giants or large-cap names from cyclical businesses.

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