REWARDING SHAREHOLDERS IN VOLATILE MARKET
Banking on robust growth in earning, many companies are rewarding their shareholders with interim dividends. The investor could consider investing in dividend yield stocks in order to provide stability to his equity portfolio.
With spectacular growth in the Indian economy, itâ€™s not surprising that corporate India is celebrating economic prosperity. On the heels of robust results, a number of companies are showering interim dividends on their shareholders. Taking a tip from this milieu, one can adopt a dividend yield based investment strategy particularly now, since the stock market is hovering around an all-time high with expectations of volatility in future.
The dividend yield ratio = Dividend per share / Current share price x 100, is a conventional valuation tool used to identify undervalued stocks. It forms the base of a good strategy for risk averse and conservative equity investors.
For instance, letâ€™s say a company is trading at Rs 120 and its long-term average dividend paid out is Rs 6 per annum. Here, the dividend yield is 5 per cent (6 /120 x 100). Suppose a comparatively risk-free interest rate (like that offered by banks on a fixed deposit) is around 8 per cent for a one-year period, this stock will have a strong support at around Rs 75. This is because, if the price goes below Rs 75, the dividend yield will become higher than 8 per cent, which makes it more attractive than the secure investment and fresh investors will begin to enter this stock, pushing up the price again. Thus, this strategy can cap capital erosion, which is of utmost importance, as the market is at an all-time high and witnessing volatility as well.
Low risk – High dividend yield stocks normally enjoy a low beta value. A low beta value means such stocks are less volatile in comparison to the overall market. Basically, a lower volatility signifies moderate risk. Though it is not possible to eliminate risk altogether.
In short, a high dividend yield ratio over the years would ensure stable returns and lower capital erosion during a bear phase. On the flip side, a low beta also means that in the case of a persistent market boom, high dividend yield stocks would witness slower appreciation than the market.
Dividend yields can be used as a basis for decisions on when to buy and sell stocks. For instance, as an entry strategy one can buy stocks with dividend yields which are twice that of a benchmark index like the Sensex. So, if the dividend yield ratio of the Sensex is 1.4 and company ABC is trading at Rs 100 with a dividend yield of 4 per cent, investors can buy this stock, as it satisfies the criteria of a dividend yield that is more than twice that of the Sensex. Similarly, one can decide to sell when the stock price appreciates and dividend yield of the stock falls below that of the Sensex. Coming back to our example, if the share price of company ABC touches Rs 290, then the dividend yield comes down to 1.37, i.e., lower than that of the Sensex (assuming the dividend yield of the Sensex remains at 1.4). In this case, the investor could exit the stock.
It is not necessary that all stocks with high dividend yields are good investment options, as not every company with strong cash flows necessarily uses these cash flows optimally. Further, low value stocks could have high dividend yields but such stocks could be perpetual laggards. If recklessly chased high dividend yield stocks may end up holding shares of companies that are not so well managed. It is a fact that although some companies have high dividend yields, they tend to remain static when it comes to growth.