Developing a Dividend Strategy

The months of July and August are welcome for all dividend investors when credit column in their bank statements become active with receipt of dividends. Long term investors understand the importance of dividends very well, more so those who depend on equities as the main source of their income. I have seen carefully crafted portfolios with dividends as the cornerstone strategy.

Dividend investors can be broadly compared to tortoise in the tortoise and hare story. If your stock picks are rights, dividend growth can be a sure way of compounding returns over a period of time.

Returns for dividend investor = Capital gains + Dividend yield

For long term investors, growing dividends year after year are a perfect way to counter inflation. Come to think of it, what greater evidence can a small investor get than a reliable stream of dividends coming to his account year after year, it shows that the company actually generates earnings after covering all its expenses, paying the interests, taxes and other costs.

What to look for in Dividend plays?

1. Consistency & Track record – The consistency and track record in paying dividends is the foremost. Mature businesses with less need for fresh capex are more likely to declare higher dividend compared to companies in growth phase and/or those having  immediate capex plans. Before formulating a view from dividend investing perspective, check out at least 5-year track record of the company, if not more. A company showing steady rising trend in dividend pay-out is preferable to one which is showing a zig zag trend. Often, we find aberrations before IPO, other fund raising exercise or some such event. The judgment for the investor lies in making a call whether the company will be able to sustain the DPS going forward.
2. Dividend yield – Dividend yield is defined as Annual dividend per share / Stock price per share. In simple terms, if company A and B both pay Rs 10 as annual dividend, the one quoting at lower market price offers a higher dividend yield. We discussed about dividend yield being one of the valuation measures here. In effect, a high dividend yield can act as a price support for the stock when markets slide. At current index level, Nifty stocks have a dividend yield of 1.52%. With the beaten down market levels being seen at the moment, it may not be difficult to pick decent stocks with dividend yield of 4% and above.
3. Dividend pay-out ratio – How much percentage of earnings is paid out as dividend determines the payout ratio. Mature companies like established FMCGs and MNCs tend to have a higher pay-out ratio. Generally, payout ratio of 20-25% and above indicates dividend friendliness of the company.
4. Exclude special and one-time dividends – It is important that investor normalizes the dividend for determining its yield, that is, after excluding any special dividends or one-time dividends linked to a particular event. For example, recently JB Chemicals & Pharma announced a special dividend of Rs 40 after selling some of its division. Smartlink Network Systems declared a special dividend of 1500% sometime back. Such special payouts should be knocked-off while analysing the long term dividend trend of any company.
5. Understanding the business – I need not over-emphasize this while making any post on stock selection. Can you take a step forward without understanding the business dynamics and its drivers?
6. Watch equity dilution since last dividend – If there is any equity dilution, i.e. number of outstanding shares have gone up due to rights issue, bonus, QIP etc, the last dividend per share may not be maintained in next year by the company on the increased paid-up capital. In such cases, past trend of dividend pay-out ratio may be a better indicator to gauge the new likely DPS.
7. Dividend policy of the management – Most companies do not have a stated dividend policy, but you get an idea from understanding of its business, concalls of the management and of course, the historical trend of the dividends.

High Dividend yield companies

List of some high dividend paying companies can be seen here.

Well, I am not going to name or shortlist any companies as the best dividend plays. It cannot be a free advice, right?

Dividends are indicators of value and also demonstrate confidence of the management in future growth of the company. Present levels in the markets can be an excellent opportunity to accumulate some good dividend yield companies in your core portfolio.

Time to become a tortoise, and emerge a sure winner!