The Hindu Business Line : Dividend yield portfolio

For businesses with reasonable growth prospects, a high dividend yield is an indicator of valuations bottoming out.
A portfolio of dividend yield stocks with reasonable prospects.

Aarati Krishnan

In the heady days of the bull market, selecting stocks with a high dividend yield meant picking up businesses with only modest growth prospects. Stocks with a high dividend yield (dividend per share/market price), and funds that constructed portfolios based on this theme, put up a poor show in the bull market of 2007. But that has changed recently.

Less liquidity chasing stocks and macro concerns surrounding the economy have given rise to doubts about whether companies can deliver to growth expectations.

With valuations whittled down across-the-board, the basket of high dividend yield stocks has also expanded substantially.

We used this opportunity to put together a portfolio of stocks that offer good dividend yield at their current prices, yet possess reasonable prospects for capital appreciation.

Given the attractive interest rates now available on debt options, a high dividend yield by itself is not a compelling reason to buy a stock. However, for businesses with reasonable growth prospects, a high dividend yield could be a good indicator of valuations bottoming out.

Therefore, investors should look at dividend yield as a measure of protection against a steep downside in the stock price.

While scouting for high dividend yield stocks, we also put these companies through other filters to gauge the sustainability of earnings and dividends, in an environment of uncertainty. Here’s how we arrived at the portfolio:

We sorted the CNX 500 constituents based on dividend yield for the latest financial year. The bar on dividend yield was set at 4.5 per cent, though some of our final choices sport a yield of as much as 7.9 per cent.

From the high dividend yield candidates, we weeded out companies that reported flat or declining profits over the past three years, retaining companies that generated a return on net worth of 15 per cent or more in the latest financial year.

The idea was to shortlist companies which, in addition to offering healthy dividends, have the ability to deliver reasonable earnings growth.

With margin pressures on the rise, companies with thin margins may see profitability under pressure, which could in turn impact dividend paying ability.

Hence, we considered only companies with operating profit margins of 15 per cent or more in the latest financial year. These margins would offer a reasonable cushion to handle any spike in material or operating costs over future quarters.

Rising interest rates pose a key risk to the earnings of Indian companies at this juncture. Companies with significant debt servicing obligations may report slower profit growth and may also be forced to curtail dividends, if interest costs shoot up.

To sidestep this risk, we whittled down our list to companies with an interest cover (profits before interest and taxes divided by interest costs), that hovers at a comfortable six times or more. These companies have a sufficient margin of safety in their profits to handle a spike in interest costs.

Finally, we checked the companies for a track record of stable or rising dividend payouts over the past three years and a comfortable payout ratio.

That leads us to a list of large-cap companies offering the prospect of a good dividend yield with reasonable growth prospects. Take your pick!

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