Money
Are dividend-yielding stocks a better bet during a bear market?
Summary
- Relying on dividends as a substitute for regular income from fixed-income instruments may not be a good idea
High dividend-paying companies are generally mature firms with fewer reinvestment needs and steady cashflows. The important metric when evaluating a dividend-paying stock is the ‘dividend yield’. The dividend yield is calculated by dividing the annual dividend per share by its current market share. For example, if the annual dividend from a stock ‘X’ is ₹10 and the stock trades at ₹300, then the dividend yield of the stock ‘X’ is 3.3%. According to past years’ data, such companies tend to do better than other stocks during the bear markets. For example, during the last couple of bear phases in India, the Nifty Dividend Opportunities 50 Index outperformed the large-cap (Nifty 50, Nifty 100), as well as the broader market (Nifty 500) indices most of the time.
Nitin Shanbhag, senior executive group VP, investment products, Motilal Oswal Private Wealth, said, “In addition to providing consistent dividend yield, many dividend-paying stocks, typically, are part of defensive sectors that are likely to weather heightened volatility and economic downturn better than cyclical sectors" and so outperform during the bear markets. As of 29 April, the Nifty Dividend index is mostly made of companies from the IT and FMCG sectors, which are defensive in nature. Companies from the oil & gas, construction and mining sectors including PSU companies also constitute a good share in the index.
“Businesses that don’t need their profits and return them to shareholders in line with a clear pay-out policy are definitely safe-haven stocks. In bear markets, they provide a safety net and also are likely to offer a price gain opportunity when money chases safety," said Shyam Shekar, founder of ithought Financial Consulting LLP. But, relying on dividends as a substitute for regular income from fixed-income instruments may not be a good idea. Dividends are variable while the interest on bonds or fixed deposits is certain, with only the risk of default. Moreover in India, the dividend yields are not very attractive compared to the returns from, say, traditional fixed deposits, which are a safer option than equity. “In India, except in very rare cases, the average dividend yield was between 1% and 3.5% in the last 30-40 years. This is unlike what we see in the developed economies such as the US, where, as per the past data, the dividend yields are higher than the bank deposits," said Tanushree Banerjee, co-head of research at Equitymaster.
Dividend-yielding stocks may also underperform when the market bounces back or during a bull market when growth stocks are favoured the most by investors. Further, dividends are not a very tax-efficient way of earning returns. Dividends earned by an investors are taxable at their slab rate (TDS applicable). But returns in the form of capital appreciation from a stock attract 10% capital gains tax above ₹1 lakh sold after a 1-year holding period.
When screening for dividend-paying stocks, a higher dividend yield with a consistent dividend pay-out policy is preferred. “When a company has a higher dividend yield, it typically means the valuations of the company are not very expensive," said Banerjee. This can be seen in the graph which depicts the inverse relationship between the valuations (represented by the price-earnings ratio) and dividend yields. “Currently, the dividend yields are higher than the average, but not like a bear market high," added Banerjee. “It is always a good time to invest when dividend yields rise in such stocks," said Shekhar of ithought Financial Consulting. Having said that, experts also caution investors about selecting stocks based on just dividend yields since a lot of variables impact this metric.
Dividend-yield funds
One can also consider taking exposure to the dividend companies via dividend-yield funds, which invest at least 65% of the total assets in the dividend-yielding stocks. There are five dividend-yield funds with at least 5-year track record. The performance of most of these funds, though, has not been very impressive. Only Templeton India Equity Income Fund was able to beat the benchmark - Nifty Dividend Opportunities 50 TRI index (Tier 1) - in the short and long-term time periods. Note that, dividend yield funds are not the same as the dividend option (Income distribution cum Capital withdrawal option) of mutual fund schemes, under which the profits from investments are redistributed to the unitholders periodically. If you choose the ‘growth’ option of a dividend yield fund, the dividends earned on investments will be reinvested by the fund. Dividend yield funds are also tax-efficient as the gains are taxed as capital gains at the time of redemption.
Conclusion
Exposure to dividend-yielding stocks should be considered for downside protection rather than to maximize returns or for regular income. Also, factor in the taxation of dividends (at slab rate). Dividends yield funds are more tax efficient, but they have not had a good track record in beating benchmarks.
