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Finding Best Dividend Paying Stocks

HomeFinding Best Dividend Paying Stocks

The last time I visited London, it was about three years ago, in the winter of 2010. As me and Manuel sat in this café back then on what was a rather chilly day, his views on a revival in the business environment were extremely promising. 

It is 2013 and I will be meeting Manuel again at the same café. It is the month of May so the weather is a little different from how it was back then. I am almost sure that his views will not be very different from back then – extremely promising about an improvement in business environment.

I like meeting him for that reason, he is positive, encouraging, and for him “things are always great” and how a kindergartener would put it, those who look at life this way are ‘happy people’.

Investing quotes

When there is a slowdown in the economy and when stock prices tank, it’s the best time to buy stocks. 

We all know that by now don’t we?

I mean, how many times have you heard this on T.V. – For long term investors it is a great time to invest?

Really? 

Just like it was last year or a year before that or 2 years before the last year, may be even longer. So basically, “for long term investors it has been a great time to invest pretty much for the last 5 years”.

Chances are that at some point the ‘long term investor’ will either run out of investable money or he will get bored of investing, at least for the long term. So while “Bad time for markets is great time for you” is a great way of looking at things, it may not always work. Yet in bad times there is one strategy which has never failed. 

Many great investors have become extremely wealthy following this time tested principle, yet it has mysteriously eluded many. To be honest, I am not going to tell you anything out of the ordinary but reading 5 minutes of this will be enough for you to get convinced that you too can benefit immensely from this principle. Observe yourself in exactly 5 minutes from now. 

I am talking of investing in high dividend yield stocks which, if done with discipline is an excellent way of making dramatic returns from stock markets. Particularly when there is a slowdown in the economy and when stock prices tank.

Motivating fact about investing in Dividend income stocks – If you had invested Rs 77,000 in ITC shares in the year 2003. You would today have in excess of Rs. 18 lakhs if you kept reinvesting all dividends in ITC. 

Dividend investing – See the full Calculation Here

When you invest in equities, you become part owner in the company and are entitled to the profits generated by its business. Companies can either return the profit to the shareholders as dividends or accumulate the profits in reserves if the management feels that it may be able to utilise the money better and earn an even higher rate of profit in future by capacity expansion, making an acquisition or by new product launches. Of course, the management could also do a bit of both (i.e. pay part dividend and transfer the rest to reserves). Typically smaller companies and companies that are in their growth stage are more likely to retain a larger portion of their profits as reserves to fund their future growth. Once this future growth is accomplished and as the business plans of such companies materialise, their share price appreciates. Investing in such companies is therefore done for capital gains more than for dividends

Investing for Capital Gains

Visit here for more on capital gains and other tax related issues.

Finding High Dividend Paying Stocks in India

The dividend yield indicates the amount which a company pays out in the form of dividends each year relative to its share price. It is a great way of measuring the amount of cash which an investor is able to generate from his or her equity investment

In order to calculate the dividend yield, divide the amount of dividends paid over the last year by the share price. 

Record Date for Dividend

Dividend Yields

The above formula will give you the current dividend yield. However, more accurate dividend yield will be obtained by dividing the annual dividend by the closing price of the share on the Ex-dividend Date (or the Ex-dividend date of the last dividend payment in case the company pays interim dividends). This is particularly relevant when looking at dividend yields for a longer duration or average dividend yields for many years. This ensures that the price captured does not reflect the appreciation in share price which results from aggressive buying made by investors before the ex-dividend date in order to become entitled to receive the dividend). A more detailed note on this aspect, and on interim vs final dividend is presented in the next section of this article (click here to go directly – Ex dividend vs Record Date) , though I suggest that you read this article before proceeding.

For example, let’s assume company ABC paid a 50% dividend per share for financial year 2012-13.  The face value of Company ABC’s share is Rs. 1 and the share’s market price or trading price is Rs. 10.

Then, Dividend per share = Rs 0.50

And, Dividend yield = 5 % (Rs. 0.50 divided by Rs.10).

Why should you care about dividend yield?

Unlike capital gains, dividends are always tax free in the hands of the investor. In addition, dividends are fairly recession proof (Note that I use the word ‘fairly’). Depending upon the profile of the company including the amount of debt on its books and its stage of growth (i.e. start-up vs. well established), you can predict with great certainty if thedividend and the dividend yield will stay consistent or increase or decrease going forward. Of course you will be looking for companies which have maintained a consistentdividend yield in the past and operate with little debt. I may also mention, when looking for high dividend paying companies focus on companies which have well established businesses and enjoy unbreachable economic moats.

The great advantage of investing for dividends, particularly at times when the markets are down is that (1) you earn a good tax free rate of return on your investment, and (2) you dramatically increase your chances of making handsome capital gains in future. Let me explain this point further with a couple of examples.

My father has certain ‘favoured stocks’ selected purely on the basis of consistency of dividend payouts and business standing in the market.  His investment approach is simple – Whenever one of these companies becomes available below a certain target price, he buys a few shares in it with a view to hold on to them forever (which somehow he actually manages to do). This approach has proved particularly beneficial for him over the last 4-5 years as the stock markets as a whole are trading at a low valuation and have been range-bound. What he was quick to observe was that the price of certain high dividend paying shares, from time to time drops down to levels where a share purchase starts resembling a fixed deposit.

Century Enka

Take the example of one of his favoured dividend paying stock – Century Enka, which has consistently maintained its high dividend yield. The stock has paid a dividend between Rs. 5-6 per equity share for the last many years. Below, I have listed the monthly low price of the stock for the past 24 months (2 years). Now, I am not trying to prove any formula or convince you that buying high dividend yield stocks is the best investment strategy ever. But somehow even though I disclaim this point, you are still likely to believe that I am doing exactly that.

Century Enka

dividend paying stocks

The rule to follow is simple – purchase a certain number of shares (say 50) anytime the share price falls below Rs. 100 and buy 50 more shares for every rupee drop in the price.

Why below Rs. 100?

Given that the company has consistently paid a dividend between Rs. 5-6 per equity share for the last many years, it is unlikely that it will not distribute at least that rate of dividend in future. Let’s assume that the company keeps paying Rs. 6 as dividend in future. If you can manage to buy the shares for Rs. 100 or below, you are surely making a 6% tax free income per annum. Any capital appreciation will be a bonus. The tag line for such an investment scheme may well be “Earn a 6% tax free interest until the day your capital appreciates by 40%”.

Problem?

No one can have endless supply of cash to keep buying with every dip. 

This is true. You must start investing for dividends with a good amount of cash reserve at the start. However, with time your dividend income will be sufficient to take care of your purchases. The trouble is that far too many investors blame lack of funding for not starting with such a plan. Others, are not disciplined enough to use their cash wisely and can’t resist the temptation of buying a larger number of shares to start up. Of course you must be disciplined to not let that happen to you. The discipline has to be such, that even when the stock had hit its bottom of Rs. 88.05 (in the above table), one should have had enough money to buy more lots of 50 shares for each rupee drop.

One may also question – Why not sell at a 20% appreciation and buy it back when it falls back to those levels. If you look at the low prices, clearly you could have done that many times. I will answer this with two points:

(1) There is no surety that the stock will become available at those levels again, and

(2) Whenever you cross a line of discipline in the markets your area of interest shifts from investing to gambling where the inherent nature of the act is such that one does it until he loses the plot. For more on swing tradingwatch this video.

An investor, who purchased Century Enka shares by this rule, is making an annual tax free dividend of 6.25%, as highlighted by the table on the left. An even more fascinating aspect is that his yield is most likely to keep increasing. As empirical evidence clearly shows, with time a company increases its rate of dividend as profitability rises. Let’s assume that the company starts paying adividend of Rs. 8 per share from 2015 and the investor does not purchase or sell any more shares. He will then receive, Rs. 8 for each of his 1,400 shares i.e. a total dividendof Rs. 11,200. His investment amount remains the same – Rs. 1,34,400, increasing his dividend yield to 8.3%.

So what must your focus be when looking for safe high dividend yielding stocks? Click here to continue reading……

About the Author

Rajat Sharma pictureRajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.