Thursday, September 1, 2011

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!


  1. Vikas said...
    Hi Shikhar,
    once again nice article.
    One personal experience I want to add.
    While choosing companies with good dividend yield one must also have a look at the debt level.
    Means few companies have huge debt but still they give hefty dividends, which I think is foolishness.
    Few Ex. PSL ltd & SRF

    And waiting for your post on Balmer Lawrie Company.

    Also what your view on Oriental Carbon & chemicals.
    If you don't mind giving below other blog link where its discussed.

    September 1, 2011 9:44 PM

  2. Hi Vikas

    Thanks for pointing out OCCL. I'll post my observations on the stock on that blog.

    You're right debt driven growth can be an issue while analyzing dividend pay-out companies. You've mentioned 2 companies, though SRF is not bad since they know how to deploy funds.

    Another 2 stocks that come to mind are Uflex Ltd and 3i Infotech, both are heavy on debt and high on dividend yield. Sustainability of such payouts is doubtful if growth is not internalised.



  3. Hi Vikas,

    I tried posting message reg OCCL on that blog but probably message is pending moderator's approval. Anyhow, my quick observations/ concerns on OCCL are as under:

    1. Question to ponder is what will make this stock expensive. Since OCCL is a strategic supplier to some tyre players, M&A could be one catalyst as you mentioned but so far no such news. So, just a matter of conjecture as of now.
    2. The product insoluble sulphur could be monopoly of OCCL. In general, industrial intermediates do not command very high multiples. Moreover, it has to be seen with industry PE for chemicals & related sector which is in 5-6 range.
    3. Not very clear why sundry debtors have gone up to Rs 29 crore in FY2011. I thought these guys should have good bargaining power being critical supplies.
    4. Management is not fancied, B2B business, stock ownership is narrow, no major funds holding, stock will continue to languish unless there is very strong recovery in broader markets.
    5. Couldn’t get exact figures on total capacity of OCCL after Mundra round of capex. They are adding 11000 MTPA in all, so by how much this will increase their existing capacity, and revenue estimates (may be FY13 for full year figure) after completing this expansion.

    Continuing weakness in market will give opportunity to add such stocks on declines.



  4. Thanks a lot Shikhar for the prompt reply.
    I have one more stock query in which RJ has invested.
    Its - Delta Corp.
    I know its in gaming business and has monopoly but how much % of Indian population will gamble?
    And its also in Real Estate business which is so full of under the table money.
    It has nice resorts, but there are at least 20 hotel stocks listed in BSE/NSE.

    But again think RJ and even his mentor Radhakiashan Damani are not fools to invest corers in it.
    Their average cost will be around 70 and don't know about the warrants.

    Can you please throw some light on this dilemma?


  5. Hi Vikas,

    I don't like Delta for various reasons. Opaque business like real estate, that too in East Africa, is more a call on the management than its actual operating performance per se.
    At the end of the day, gaming is also a largely cash based business.

    I won't understand their preferential allotment stuff done at Rs 50 in Oct-2010, large differentials in dividends etc.

    From RJ picks, I'm ok with Srei which I've tracked since long, will post on it sometime.



  6. Hi Shikhar,
    Thanks for your views on Delta Corp.
    I am also following SREI infra since RJ took stake in it. And have seen it going from 40 to 100 and then again to 40.
    Personally dont like infra.
    It was fine till Infra finance but now they have entered into proper infra which I dont like.
    Also went through recent Annual Report from web-site and found the Mx very phony by saying 'GAME CHANGER'.

    Again personal thinking.
    Your detailed views are welcomed.


  7. Hi Vikas,

    You're right Srei is now a diversified infra play instead of finance. At present, it quotes below the book.

    Value-add from Quippo entities need time, so this might be suitable only for investors with minimum 3-year type outlook.

    On price, you're confusing with its cum-bonus price. It issued 4:5 bonus in Feb-2011.



  8. Hi Shikhar,
    Posting below the link of Radhakishan Damani's ( Rakesh Jhunjhunwala's Mentor)stock portfolio