From THE HINDU group of publications
Sunday, June 03, 2001


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Total returns matter more -- Look beyond dividend yields

DOES it pay to invest for dividend yields?

If you ask small investors, the answer will invariably be yes. However, the profitability of an investment based on dividend yield should also account for capital gains and losses for the companies. Business Line analysed a small sample of around 200 stocks with a reasonably good profile that were actively traded between 1995 and 2000.

Before going into the details of the analysis, we need to know what is meant by dividend yield and total yield. Dividend yield refers to the ratio of dividend to the initial price. For instance, if a company has a dividend per share of Rs 2 and a market price of Rs 10, the dividend yield works out to 20 per cent (2/10*100).

In general, companies with low growth prospects offer a high dividend yield, against those with high growth prospects. Total yield refers to the sum of dividend yield and the capital gains/(losses) suffered by the investor.

Not so impressive

If one were to invest based on dividend yields alone, which companies would be the most attractive? From the larger list, we shortlisted the companies that had a fairly good profile and provided dividend yields greater than 8 per cent for the year 2001. The sample provided a list of around 60 companies.

The list (see Table for complete list) included companies such as Ashok Leyland Finance, Industrial Development Bank of India, Goetze (India), Punjab Tractors, EID Parry and Hind Lever Chemicals, among others. Classifying the data based on industry, automobiles and chemicals head the list, represented by 12 companies.

Click here for Table

Of the sample, an analysis of around 20 companies for total yield over the five years indicates that in 65 per cent of the cases, an investor would have suffered a net loss. Given the industry-wise classification, both automobiles and chemicals, which have the maximum representation, have not been doing well in recent times. Therefore, capital appreciation in these companies is not likely to be good. In this backdrop, it does not make sense to adopt a buy-and-hold strategy. But it may make sense from a `dividend capture' standpoint.

Dividend-capture could be profitable

A buy-and-hold strategy using dividend yields assumes that one invests for dividend yields and holds the stock for a fairly long time. However, investors can profit on aberrations in market valuations. A strategy which may pay is to `capture dividends'. Normally, investors start bidding up the prices of those companies which pay dividends regularly, at around the time of the dividend announcement.

Investors who know about companies that declare dividends regularly, can buy the stock around the time of dividend announcement, hoping for a good capital appreciation along with the dividends. Since most of the shares are moving into the demat mode, investors can get out of the position soon after the ex-dividend date. By adopting this strategy, investors are likely to end up with positive returns.

But even here, it would be wise to look at specific stocks that are liquid enough for investors to close their positions. Stocks such as IDBI, Ashok Leyland Finance, EID Parry, Hind Lever Chemicals, among others, are good options in this category.

This apart, we find that a few companies find their place in both the high dividend yield and positive total return list. For instance, two stocks that warrant attention are Oriental Bank of Commerce and Swaraj Engines. In both these stocks, invariably, investors following a buy-and-hold strategy would have had reason to smile as, in most years, they have provided positive total returns. But, apart from these exceptions, the general trend is that investing purely on the basis of high dividend yield is not profitable.

Total returns

The analysis indicates that, on average, 57 out of 100 companies give the investor negative total returns. In terms of industry classification, the best performers on total yield are housing finance, finance and cement companies. The worst performers are pharmaceuticals, technology and banking. But there are exceptions. For instance, if we rank the stocks on their individual merits, Infosys Technologies and Hindustan Lever rank near the top. However, these are not all dividend plays.

A statistical analysis of the data indicates that, on an average, the mean dividend yield has shown a rising trend. Over the five-year period it peaked in 2000 at 9.27 per cent. However, investors have to note that dividend yield has an inverse relationship with price. Hence, in a bull market, even if the dividend rate is high, as the share price is relatively higher, we may find the dividend yield is lower.

Similarly, in a bear market, when share prices are hammered down, dividend yields tend to move up. Dividend yields have averaged 3-4 per cent during the bull market in 1994 and 1995. The dispersion around the median values is much lower than the averages. For instance, if one goes by the median values, the dividend yield levels in 1998 and 2000 are at par.

An analysis of frequency distribution of the yield data indicates that in the less than 4 per cent category, there has been a substantial drop in companies -- around 71 per cent since 1995. The 14-24 per cent range is relatively more stable, with a drop of only 39 per cent. For instance, Kochi Refineries, Knoll Pharmaceuticals, IDBI, Thirumalai Chemicals, Ashok Leyland Finance, EID Parry and Chennai Petroleum Corporation, which form part of this group, may be considered for investment. But it is essential to track their performance in terms of capital gains also.

Positive trio

The analysis on total yield indicates that only three companies gave positive total returns in five of the six years covered. The three are Infosys Technologies, Hindustan Lever and Oriental Bank. The gains in Infosys can be attributed to capital gains, to a large extent, but both HLL and Oriental Bank have been giving a fairly good dividend yield over the last few years. Other companies at the top of the list include SBI, Mirc Electronics, BHEL, Cummins India, Gujarat Gas, NIIT and Hindalco, among others.

From the analysis, it is evident that investors may not find a dividend play all that attractive on most occasions, especially looking at it from a buy-and-hold viewpoint. What is required is to identify those companies with a consistent dividend payment record and whose market risk is lower. Such companies could offer good profit opportunities, especially with a dividend-capture strategy.

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