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Dividend Yield Stocks: Bear Market Lifeboats

Monday, April 16, 2018
By V K Sharma

V K Sharma, Head PCG & Capital Market Strategy, HDFC Securities.

When the markets are down and stocks are cheap, it is an opportunity to look for high dividend yield stocks.  As long as you hold the stock concerned and as long as the company continues to pay dividends at the same rate, your dividend yield is fixed for life, even if the market price of the stock changes subsequently.

Other things being equal, the yield will be higher if you buy stocks at lower price.

Let me make it clear that we are not in a bear market as yet. We are down just 9% from the all-time high mark seen on January 29. The current state of the markets can only be defined as a correction.

When you are not sure how long the correction will last, a good dividend yield will give you a steady income and therefore you can afford to forget what the index or stock is quoting at. You treat the stock more like a fixed deposit where you get your fixed returns. Therefore, you have less tension.

Calculating the dividend yield
How do you calculate dividend yield? Take the dividend per share for the full year and divide that amount by the price at which you acquire that stock. Multiply this outcome by 100 and you get your dividend yield in percentage terms.

Dividend is tax free
Dividend is tax free in the hands of the investors to the extent of Rs Ten Lakhs per annum. This is a huge benefit. Even if you earn more than Rs ten lakhs, it gets taxed at only 10%, which is much less than your marginal tax rate of 30% and even less than Short Term Capital Gains tax of 15% and equals Long Term Capital Gains tax of 10%.

For instance if you earn Rs 15 lakhs as dividend income, the first 10 lakhs is exempted from Income Tax. And you pay just Rs 50,000 as tax, i.e. 10% of Rs 5 lakhs.

Many reasons for a stock to fall; one to hold
In a bear market, stocks get hammered for various reasons. The fundamentals could have gone bad so investors sell. The seller may be in need of money and therefore he is selling. Either the broker or the bank with whom the shares were pledged, sells on margin short fall. Some of the triggers may have come from the technical studies, like the stock breaking a particular trend line, support level or moving average. Some of the  selling may  be pure short selling, some may be selling because they are booking profits and some may be selling because somebody just asked them to or just because they had this gut feeling that they should get out of the stock.

Whatever the reason of the sale, sustained selling allows you to pick stocks at lower rates. As prices go lower the dividend yields go up. So these bear markets are essentially shopping seasons for stocks, when you can pick and choose your stocks.

Such times are also good times to buy for growth as well. But since there is no certainty as to when stocks would bottom out, you don’t tend to buy when they are low. And when they start rising, you are not sure whether a bull market has begun, and you still wait. After some time when the bull market is fully established, the rates have risen so high that you fool yourself into thinking that when I didn’t buy when they were low, why should I buy now at higher prices?

But the moment you start looking at stocks from dividend yield point of view, you start becoming comfortable with the markets and begin to find logic in investing in the markets at current rates, when others are staying away. Infact, your comfort gets so high that you start celebrating a market fall.

Look before you leap?

But before you jump into buying stocks pay full attention to the following points.

Look at the past track record. Does the company pay dividends regularly? Is there a noticeable pattern of say steady dividends, or increasing dividends? In case there is one it would be of immense help in decision making.

Do some crystal gazing. Will the company be able to maintain the dividend, especially in times of falling profits? Also look at the pay-out ratio. If a company pays out a higher percentage of profits as dividends, then it is more susceptible to a dividend shrinkage should things go wrong in the future. But if there is a consistent high pay out and the dividend is rising then there is a good chance that the stock may have a higher PE and a lower dividend yield and may not even figure in your short listed stocks.

Having a Government shareholder reduces a lot of risk of lowering of dividends.

In companies like Coal India, the Government, which holds 78% in the company is more interested that the company pays as much dividend as is possible so that it can balance its fiscal deficit better.

As a result, there are years, when the company has dipped into reserves to pay higher dividends when the company’s earnings of that particular year have not been sufficient.

But Government companies are a double edged sword. Should the Government come out with an offer for sale to reduce its holdings, it can keep the stock subdued for some time. On the other hand, a strategic sale of PSU can make you reap instant capital appreciation.

Some companies pay annual dividends and some pay interim dividends as well. Just total them up before you start your study. There is a short term opportunity in stocks which pay annual dividends. Most companies have March as year-end. They will have their AGMs in June-July and dividends may go out by July-August. So assuming even if you get your dividends by September, full six months down the line, a stock that gives you an 8% dividend Yield may actually mean 16% on an annualised basis for the first six months, assuming the stock price remains same to give you the exit at cost. While choosing bouquet of stocks it would be advisable to choose different industries to diversify your portfolio.

Dividend Yield Stocks

Exit Strategy
Though you are wanting to hold the stock for the long term, I suggest that you have an exit strategy in place. When a stock gives you 3 times its dividend yield in terms of capital appreciation, go back and ask your RM to evaluate the stock for you and take his view whether to hold or sell.

Though the stocks that give high dividend yield are not likely to be the best of investments in times of growth but because you can hold them through a bear market due to the comfort of dividend yield, you can reap your capital appreciation harvest as well in the next bull market.

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