An ET Wealthanalysis of nearly 1,200 firms reveals that the companies which provide regular dividends also offer higher capital appreciation for investors.
Investors love high-dividend stocks because they fulfil two basic needs. These stocks provide a regular income and are relatively less volatile than other scrips. The dividend yield acts as a safety cushion that prevents the scrip from going into a free-fall. However, these are not the only reasons you should consider the dividend yield stocks. ET Wealthanalysed nearly 1,200 listed companies and found that in the past three years, the companies that have paid regular dividends have also offered high capital appreciation to investors.
The dividend discount model says that the price of a stock is the present value of the future dividends discounted at an appropriate rate. If the discount rate is constant, an increased stream of dividends will lead to a higher value, and vice versa. In other words, the companies that boost their dividend payment are likely to outperform the stocks that have contracting dividends. This implies that the stocks that pay dividends are not only a good source of regular income, but are also better wealth creators than other stocks and investment avenues.
To test this theory, we analysed 1,183 companies and studied their dividend payment patterns for the past three financial years. The stocks that had not paid any dividend in the past three years were excluded from the analysis. This left us with 586 stocks. Next, we categorised these stocks into two groups. The first included companies that had consistently increased their dividends in the past three years. The second group comprised firms which had either reduced their dividends or where the payout had remained stagnant in the past three years.
The importance of dividend payout was clear when we analysed the price performance of these two groups between 31 March 2009 and 29 July 2011. In the first group, the stock prices of the companies that had increased the dividend payment had appreciated by 286% on an average. The share prices in the second group, which included companies with falling or stagnant dividends, had risen by 129% on average. During the same period, the Sensex, which also included companies that had not paid any dividend, rose by 87.44%. All these returns are in absolute terms.
This underlines the market's perception of dividend payout. Both groups contained dividend paying stocks, but the first group generated more than twice the returns delivered by the second group. Also, both managed to outperform the broader market. Whether they increase or decrease the dividend payout, the stocks that give a regular income will be able to outperform the general market substantially.
Does this mean that dividend stocks always outperform other stocks? Says Sudhakar Shanbhag, chief investment officer, Kotak Mahindra Old Mutual Life Insurance: "When the dividend yield is higher than the risk-free interest yield, these stocks will outperform. Also, in a volatile or bearish market, the company's fundamentals will hold these stocks in good stead." The yield of the benchmark government bond is considered a proxy for the risk-free rate. In India, the 10-year government bond yield has averaged 8.1% in the past year.
However, people should not invest in such stocks blindly because some companies tend to pay dividends just to soothe their shareholders. So, investment in such firms may not be fruitful in the long run. Says Shanbhag: "The best way to look for such anomalies is by checking whether the dividends are from the current cash profits."
This helps separate the chaff from the grain. The dividend should have been paid from the company's operating profit. It makes little sense to distribute cash to shareholders when the company isn't making any.
We also analysed the dividend payments according to sectors (see graphic). So, which were the most generous dividend payers and which were the most niggardly? The IT industry was the most generous, with its dividend payments increasing by over 2,318 crore in 2010-11 compared with 2009-10. Banks came next with an increase of 2,158 crore, followed by the pharma industry. The tobacco industry made the unkindest cut, reducing its dividend by 351 crore.
We have identified five fundamentally sound dividend paying companies that can make for good, stable investments. All five are established players in their respective sectors and are included in the S&P CNX Nifty. The share prices of these stocks have been hammered down due to the global crisis. This only makes them more attractive for the long-term investor. Among these five stocks, Bajaj Auto tops with its 100% dividend growth in 2010-11 over the previous year.
Tata Motors
India's largest automobile manufacturer designs, manufactures, assembles and finances automobiles of all shapes and sizes. In the April-June quarter of 2011-12, Tata Motors' consolidated revenue grew 24.1% y-o-y to 33,570 crore. JLR's volume grew by 4.9% y-o-y to 62,090 vehicles. The prices in the commercial vehicles as well as passenger vehicles segments rose by approximately 2% in the beginning of the quarter. The company's JLR segment is likely to perform well due to large investments in research and development (R&D), and savvy product segmentation. The demand from China and other emerging markets will remain firm even if the demand from developed markets slips (due to concerns over recession). The stock presents a good buying opportunity.
ICICI Bank
The financial powerhouse and its subsidiaries offer a wide range of services, including commercial banking, retail banking, project and corporate finance, life and general insurance, venture capital and private equity, investment banking and broking services. The bank reported robust results for the first quarter of 2011-12, with net profit growing by 29.8% y-o-y to 1,332 crore. The asset quality is continuously improving at both the delinquency and recovery level. Its net interest income grew 21% y-o-y, supported by a steady loan growth. Looking at the consolidated results that include the performance of subsidiaries, its consolidated net profit grew 52.8% y-o-y and 6.3% q-o-q led by a strong core performance in banking, life insurance and general insurance. The stock is an attractive buy.
Bajaj Auto
This two- and three-wheeler manufacturer is wellknown for its R&D, product development, engineering and low-cost manufacturing skills. In the first quarter of 2011-12, its net revenue grew 23% y-o-y to 4,780 crore. The volume grew 17.7% y-o-y to 1.09 million units, driven by a 16% y-o-y growth in motorcycles and a 30% y-o-y growth in threewheelers. The company has increased its stake in Austria's KTM Power Sports AG to 39.26% and might consider taking it up to 49%. Moreover, the increasing penetration in rural markets and replacement demand from urban markets makes the industry dynamics favourable. At the current price, the stock is available at a good valuation.
Dr Reddy's Laboratories
This global pharma company has proven research capabilities and presence across the value chain. It conducts research in diabetes, obesity, cardiovascular diseases, anti-infective products and inflammation. The company reported higher-than-expected results in the April-June quarter of 2011-12, with its overall net profit growing by 25.1% y-o-y to 262 crore. The company has entered into strategic alliances with GSK and Valent Pharma that will assist in its longterm growth. At its current price, the stock presents an attractive investment opportunity.
Larsen & Toubro
India's largest engineering and construction company posted an impressive first quarter results, with its revenue up by 21% y-o-y to 9,480 crore. Its net profit increased by 12% y-o-y to 740 crore. Its order book includes large orders like the 1,200 crore Hyderabad Metro, 1,700 crore for the four-laning of National Highway 14 between Beawar and Pindwara, in Rajasthan, and a 1,400 crore power plant for PPN. L&T is fundamentally the strongest company in the industry and makes for a good buy at current levels.
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