BUYING DIVIDEND STOCK - TIMELESS INVESTMENT TOOL?

By Ruma Dubey

Till a few years back, if you asked any of the old time investors about their criteria for making a sound investment decision in stocks, the dividend paying ability figured very high. And now, as all other things have changed, this age-old adage also seems to be undergoing a change. Investors still do look for dividend paying companies but it is not high on the priority list, at least not for the new generation.

It is seen that there are now very few investors who really wait with bated breath for the dividends to come in. And this probably has happened because companies themselves offer very small dividends as against the stock market price. Hence the investor starts looking more at capital appreciation.

And this seems to have brushed off to the companies, who despite sitting on huge piles of cash, prefer to be stingy when it comes to dividend payout. In a report filed by Institutional Advisory Services, it states that in 2012, of the total 457 profit-making companies in the BSE 500 universe, 409 companies had declared dividend. Only 67 companies had a payout ratio of more than 50%. HCL Infosystems, GlaxoSmithKline Pharmaceuticals, Castrol India and Colgate-Palmolive were some of the companies had paid consistently paid over 50% dividends in the last five years. But the report states that when looking at dividend paying consistency over the last five years, the number declines to 349.

If one were to look at the top 5 dividend paying companies in Fy13, like always Colgate-Palmolive tops the list and it paid three interim dividends – Rs.13, Rs.6 and then Rs.9 – total dividend paid was Rs.28 per Re.1 share held. And now for FY14, it has once again declared three interims – each of Rs.9 per share; total Rs.27/share. Others in the list would be ITC, Hawkins Cooker, HDFC Ltd, Gruh Finance, Emami, Eicher Motors. Infosys has been especially generous for FY14, declaring a total dividend of Rs.12.60/share of Rs.5 face value. PSY stocks have all given hefty dividends for FY14, even though it was under duress.

So what does one do? Make all investment decisions based only on dividend payout? There is no denying the fact that dividend is and will remain the best tool to determine the fundamental value of any stock. For long term investors, dividend is the only return which he gets, year after year. And in such cases, dividend-based valuation is the most appropriate to estimate investor’s return.

So how does one calculate this return? Very simple. One can arrive at the return by dividing the expected dividend by the stock price and adding the dividend growth rate to it (expected dividend/stock price + dividend growth rate). And while doing this, it is imperative to remember that when the dividend is negligible, growth rate of the dividend is the determining factor for long-term return.

Does this mean that for a short term investor, dividend holds no relevance? When one looks at short term investment, naturally, capital appreciation is the highest priority. But dividend can become a decisive factor if the dividend yield is high. This dividend yield is arrived at by dividing the last annual dividend with the current price. But there is a stick to this carrot. Dividend yield is a great return only if the price remains at the same level and the company sticks to the same dividend rate. If the dividend rate remains the same but the price goes down then the return is naturally below the dividend yield. And if the price goes up, the return will be higher. Thus in the eventuality of a capital loss, investors cannot earn a return equal to the dividend yield.

If dividend is indeed the criteria for investment then it is imperative to check the dividend history of the company. A company with a long and consistent (if not growing) dividend trend is expected to stick to it in the near future. But if the profits go down, naturally the dividend rates will also come down. Hence while making a decision it is important to take a complete overview of the company and its profit making ability.

Yes, dividend paying ability is an important criterion in deciding on investment but it cannot be the only one. An overall insight into the nature of the company’s business, balance sheet is imperative. The logic is simple – if business is faltering and profits are dipping, naturally dividends will also come down.