Depending on the risk profile of investors, experts suggest that dividend-paying stocks could constitute 20-60 percent of one’s portfolio.
If you are looking to play safe in equity markets and want to avoid taking risks, don’t miss out on stocks that offer dividend on a regular basis. They might turn out to be multibaggers but investors will be able to generate a steady flow of risk free income from such stocks.
Dividends are distributed by companies out of their profit after tax. A dividend payout ratio indicates how much a company pays out in terms of dividends compared to its share price.
History suggests that dividend paying stocks are less volatile in times of uncertainty or steep corrections. While selecting such stocks investors should look for stability in the underlying business of the company, along with its ability to generate cash flows to pay dividend.
According to a report by IDBI Capital, top 10 stocks with high dividend yield and double-digit return on equity (RoE) include: Rural Electrification Corporation, Coal India, Accelya Kale Solutions, Castrol India, Procter & Gamble Hygiene & Health Care, Infosys, InterGlobe Aviation, Bajaj Corp, Hindustan Zinc and Hero MotoCorp etc. among others.
“At a fundamental level, the return of capital to shareholders by way of dividends generally tends to be sticky and less volatile compared to fluctuation in earnings. The idea is to declare dividends, which can be maintained even in a downcycle,” Harish Krishnan, Fund Manager-Equity, Kotak Mutual Fund, said.
“Ultimate wealth creation comes from tracking the fundamentals of companies, of which dividend track record is an important parameter. One needs to see whether the management rewards shareholder with near term dividends or deploys capital in more value creating opportunities for the future,” he said.
Should investors buy stocks that only offers dividends?
Experts feel investors should invest in growth stocks and not put too much emphasis on dividend payout. Depending on the risk profile of investors, they suggest that dividend paying stocks could constitute 20-60 percent of one’s portfolio. However, they were quick to add that investors should avoid depending too much on dividend paying stocks for long term value creation. “Despite helping in curbing volatility, it might not come in handy when it comes to value creation.”
Atish Matlawala of SSJ Finance cautions that not all stocks with a high dividend yield are attractive. “Investors should evaluate the company’s future prospects before investing. If the fall in prices is due to challenging future prospects, then a high dividend payout may not necessarily sustain going forward.”
He advises investors to check if the company has a generous payout policy or if it is a one-time event. “If future prospects of the company are bright and it has generous payout policy, then investing in such companies will protect the downside and generate superior returns when market sentiments improve.”
According to Matlawala, if the only criteria for acquiring a stock is its dividend yield, then one should buy only if the yield is more than 3 percent or half of the prevailing fixed deposit rates.
Dividend and stock prices
When a company increases its dividend yield, the company’s price-to-earnings reacts negatively. This is because higher dividends are seen as a signal that there are not too many growth opportunities in the company.
“Dividends are cash payouts and to that extent they reduce the value of a company. When we talk of value, we refer to the networth of the company and its market value. Since shareholders pay for growth, a higher dividend payout does not help valuations. That explains why oil marketing companies quote at low valuations despite generous dividend payouts,” Jaikishan Parmar, Senior Research Analyst at Angel Broking, said.