The Hindu Business Line : After eight years, the `dividend dogs' disappoint

The Dogs-of-the-BSE 100 trailed the index returns in 2005 for the first time in nine years. Yet this is a strategy that can still deliver value. Our portfolio for 2006: SAIL, Chennai Petroleum, HPCL, Shipping Corporation, Vijaya Bank, GE Shipping, JSW Steel, Allahabad Bank, Tata Steel and ONGC.

FOR eight consecutive years, the Dogs-of-the-BSE-100 strategy had delivered returns superior to that of the index itself. For three years in a row, it had also delivered returns that were better than that of the average diversified equity fund. That streak was broken in 2005.

In the year that just ended, the Dogs of BSE-100 delivered returns of 15.3 per cent. The BSE-100 registered returns of 38.4 per cent. The average mutual fund delivered returns of 48 per cent.

The strategy's value has, however, not diminished at all. It would not be prudent to discard any strategy that has done well in three out of four years. Besides, unusual conditions were behind the under-performance in 2005. If market forces had been allowed to run their course, the returns from such a strategy would have, in all probability, been superior to those from the index.

In addition, the Dogs of BSE-100 have turned in positive returns for nine consecutive years, while the BSE-100 itself has turned in negative returns in three of the past nine years.

Behind the strategy: The `Dividend Dogs of BSE-100' strategy is similar to the `Dogs-of-the-Dow' strategy followed in the US. In the US, the strategy involves investing in stocks that are a part of the Dow Jones Index and have a high dividend yield.

The strategy has been found to beat the market consistently in the US. Adapted versions of the strategy in the UK and Canada have also delivered index-beating returns.

The strategy in India involves:

ranking stocks that are part of BSE-100 in terms of dividend yield;

picking the top ten stocks in terms of dividend yield;

investing equal sums in these stocks; and staying invested in them for a year.

Poor show in 2005: Seven of the 10 stocks in the 2005 portfolio were from the public sector. The non-public sector stocks in the portfolio — Hindustan Lever, Hero Honda Motors and GE Shipping — comfortably outpaced the index, delivering returns of 40 per cent plus.

Stocks that were hobbled by Government policies proved to be a drag on the strategy's performance. Four of the 10 stocks were particularly handicapped by inaction on the Government's policy front — BPCL, HPCL, Kochi Refineries, Indian Oil and Vijaya Bank. Average returns for the other five stocks were almost on par with the BSE-100's returns.

It is possible to argue that if Government policies had changed faster, then performance would have been far better.

This argument is irrelevant to analyse the strategy's performance in 2005; but it is valuable when we consider its usefulness in the years ahead. This is because if you feel that inaction on the policy front would not turn out to be such a critical negative factor for PSU stocks every year, then it makes sense to persist with the strategy.

This conviction is necessary as the portfolio for 2006 also contains stocks of seven public sector companies.

Portfolio for 2006: The following stocks make it to the portfolio for 2006: SAIL, Chennai Petroleum, HPCL, Shipping Corporation, Vijaya Bank, GE Shipping, JSW Steel, Allahabad Bank, Tata Steel and ONGC.

The average dividend yield of this portfolio is 4.3 per cent, which is identical to the dividend yield offered by the top ten stocks at the beginning of 2004 and 2005. The dividend yield for BSE-100 is 1.6 per cent.

For all the past performance of this strategy, the portfolio for 2006 is hardly inspiring. Only four sectors are represented in this portfolio — steel, shipping, public sector banks and oil.

All four suffer from poor visibility on the earnings growth front, and this is reflected in the valuation of stocks. The average price-to-earnings multiple of the stocks is five, compared to 17 for the BSE-100.

This strategy does, however, presume that concerns relating to company performance are overdone. Prices are beaten down more than warranted, and the stocks are thus trading below their intrinsic value. This premise was proved to be wrong in 2005, although it worked wonders in the earlier years. As far as 2006 is concerned, principal risks to the portfolio performance stem from a continued increase in crude oil prices. This could affect the performance of Chennai Petroleum and HPCL. It would also affect margins of SAIL, JSW Steel and Tata Steel.

Shipping volumes and prices would also be affected, as the global economy would slow down. Vijaya Bank and Allahabad Bank could also suffer due to a rise in interest rates related to rise in crude oil prices.

If the crude price cools down all stocks in the portfolio would benefit in different ways. ONGC will be unaffected as its realisation is still considerably below the prevailing international crude price.

Such a boost to portfolio returns will also enhance the value of the strategy considerably.

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