During a bull run, it’s very easy to ignore stocks with high dividend yields. But in times of crisis, these are the most sought after because not only do they provide a cushion in a falling market, they also tend to fall less. These stocks offer capital appreciation as well as cash payments. But logically, any company that pays a substantial portion of its earnings in dividends is reinvesting less and, therefore, would grow at a slower pace. So the trade-off is between higher dividend yields for lower earnings growth. On the other hand, companies with high growth potential and volatile earnings tend to pay less by way of dividends, if at all. Such companies would rather reinvest their earnings to sustain their growth. The capital appreciation of growth stocks is obviously higher than in dividend yield ones.
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But it does not mean that every stock that pays dividends is a worthwhile pick. The trick is to find companies which tend to generate a lot of cash with modest, but steady growth. Brokerage firm India Infoline conducted a study on dividend yield stocks in August. Using a screening methodology to ensure that the results were not skewed towards small-cap stocks and to even out the risk-reward in the selection, it zeroed in on 25 companies from the BSE 500.
These companies had dividend yields ranging from 3.5% (Tata Motors) to 8.9% (Bongaigaon refinery). According to the study, 14 companies were stable dividend payers, but to a great extent, aided by the strong economic growth in the last few years. Fifteen of them reported a significant y-o-y decline in profits in the latest quarter (April-June).
Investors need to study the prospects and fundamentals of a company before taking any investment call, including dividend yield stocks. As dividend yield is based on past performance, it is hardly an indication of the future profitability and sustainability of the dividend. Investors must look at growth potential, quality of management, industry prospects and macro issues.
For instance, given the current economic scenario, it would be wise to avoid companies with high debt or large capex plans even if the dividend yields are attractive. One option for investors looking at such stocks would be to consider dividend yield funds. A good dividend yield fund would be one that does not focus solely on stocks with the highest dividend yield but aims at finding the best overall investments.
If you look at the six dividend yield funds available, what comes across is their own interpretation of what makes a stock a “high dividend yield”. Three funds stand out in this list. These are the ones that have been consistently appearing in the top performing list as equity funds continue to plummet. It’s not that the net asset values of Birla Sun Life Dividend Yield Plus, ING Dividend Yield and UTI Dividend Yield have not fallen.
It’s just that they are amongst the least unfortunate (in terms of one-year returns). However, all of them do not appear in the above analysis. We have looked at UTI Dividend Yield, Tata Dividend Yield and Birla Sun Life Dividend Yield Plus, which have proven to be the better bets over time.