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Suresh Krishnamurthy

In 2003, a strategy of investing in high-dividend yield stocks forming part of BSE-100 delivered returns for the seventh year in a row. However, 2004 could prove to be tough year as high-dividend yield stocks have been marked up sharply.

IN 2003, for the seventh-year running, the average return generated by the BSE-100's dividend dogs was higher than that of the BSE-100.

Dividend dogs are those stocks in the BSE-100 that had the highest dividend yield at the end of 2002. The strategy in 2003 has worked impressively — the average returns of these stocks, at about 177 per cent, is higher than the 166 per cent return generated by Franklin India Prima, the top performing fund in 2003.

Investing in the BSE-100's dividend dogs is similar to the strategy of `Dogs of the Dow' followed in the US. There, the strategy involves investing in the high dividend-yielding stocks that are part of the Dow Jones Index. The strategy has been found to beat the market consistently in the US.

Adaptations of the strategy in the UK and Canada have also delivered index-beating returns. In India, the strategy has not lost money in any of the last seven years. In contrast, the BSE-100 index lost money in three of the last seven years.

Dividend dogs: The strategy involves ranking BSE-100's stocks in terms of dividend yields. Investments are then made in the top ten stocks in equal proportions.

After the end of the year, these stocks are sold. The index stocks are then ranked again and investment made again in the top ten stocks.

For the analysis, the stocks are ranked in terms of dividend yields at the end of each calendar year.

The dividend declared for the earlier year is considered. However, when calculating the return, the dividend declared for the following year is considered.

For example, for 1997, stocks were ranked considering the dividends declared for the year ended March 1996. When calculating returns, though, the dividends declared for year ended March 1997 were considered.

Chosen stocks: The strategy chose the following stocks at the end of 2002: GE Shipping, Procter & Gamble, Hind Lever Chemicals, Tata Chemicals, Gujarat Narmada, HCL Infosystems, IDBI, Hero Honda, Neyveli Lignite and SSI. GE Shipping recorded the highest return of about 383 per cent.

In contrast, Hero Honda recorded the lowest return of about 78 per cent. Four of the chosen stocks — Procter & Gamble, Hind Lever Chemicals, HCL Infosystems and SSI — were removed from the index during May 2003.

Importantly, except SSI and Hind Lever Chemicals, the dividend declared by all the chosen stocks in 2003 was similar to or higher than what was declared in 2002. This is a vindication of the strategy of focussing on the BSE-100.

Employing the dividend yield strategy is generally considered risky, as the previous year's dividends could prove misleading. However, by restricting the universe of stocks to the BSE-100's constituents, the risks due to liquidity, corporate governance or dramatic swings in dividend declared are, to an extent, controlled, compared to a dividend yield strategy that focusses on a larger universe of stocks.

Tough year ahead: Notwithstanding the superior performance of the strategy in the past seven years, 2004 could present a stiff challenge.

The market is on a high, investors have lapped up high dividend-yielding stocks and not many stocks in the BSE-100 now yield dividends in excess of 5 per cent.

The average dividend yield of the top ten dividend dogs was about 7.5 per cent at the end of 2002.

At the end of 2003, the top ten dividend dogs offer an average yield of about 4.4 per cent, with only two offering a yield of over 5 per cent.

Still, the strategy will be useful as it provides investors with an opportunity to diversify the portfolio.

This strategy could come in handy for investors if there is a market-wide correction in stock prices as the downside risks are expected to be relatively limited for high-dividend-yield stocks.

Keeping these factors in mind, let us consider the picks that the strategy identifies for 2004: Chambal Fertilisers, Videsh Sanchar Nigam, Hindustan Petroleum, Bank of India, Andhra Bank, Indian Oil Corporation, Union Bank of India, Hero Honda, ONGC and Gujarat Narmada.

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