Personal Finance

High dividend yields can be deceptive

Aarati Krishnan | Updated on October 20, 2019 Published on October 19, 2019

Investing for dividend yield in India is a minefield. Here’s how you can navigate it

With shaky banks and defaulting NBFCs, many Indian investors are beginning to wonder if dividend-yield stocks are a better bet for their income needs. The recent market correction has also expanded the basket of stocks offering lucrative double-digit dividend yields.

But dividend-yield investing in India, like value investing, is a minefield. To succeed at it, you’ve got to put extra effort into researching a company’s profit and dividend history and business prospects. Simply running a screener to choose high- yield stocks for your portfolio can land you in hot water. Here are some checks to avoid the risks.

Special dividends

Most stock screeners calculate dividend yield by dividing a company’s latest annual dividend per share by its latest stock price. While this is indeed the correct way to capture dividend yield, selecting stocks based on this parameter can leave you high and dry if the ‘yield’ was propped up by a one-off dividend in the latest year.

Companies that are regular dividend-payers may suddenly declare a special dividend in a particular year to distribute proceeds of an asset sale or a spin-off. P&G Health (formerly Merck) today pops up on many ‘high dividend yield’ screeners because it declared a total dividend of ₹440 per share for CY2018, translating into a 10 per cent dividend yield on the current stock price of ₹4,400. But if you buy the stock hoping to mop up 10 per cent from dividends every year, you’d be sorely disappointed because that’s not a sustainable payout.

In 2018, ₹416 of the company’s ₹440 dividend per share came from a special distribution that it had made after transferring its biopharma and life sciences business to Merck Life Sciences. Companies also declare special dividends to mark anniversaries or other landmark events.

So, if you find a quality stock with a dividend yield that looks too good to be true, double-check for a special dividend in the latest year. Strip this out from its average dividend per share for the past five years to calculate the sustainable dividend yield.

Unpredictable earnings

Graphite electrode and carbon products maker Graphite India currently figures on many high dividend-yield shopping lists because its dividend for FY19 at ₹55 per share translates into a hefty dividend yield of over 20 per cent on its stock price of ₹270. But its dividend history shows that the company, which paid modest dividends of ₹2-3 per share for the 10 years from FY07 to FY17, suddenly ramped them up to ₹17 in FY18 and ₹55 in FY19.

The jump in dividends can be traced to a sharp pick-up in the company’s fortunes which saw its reported profits shoot up from ₹112 crore in FY17 to over ₹2,800 crore in FY19.

But after this stellar growth, it has seen its revenues halve and profits fall 77 per cent in the recent April-June quarter.

Given that the company’s profits (and thus dividends) are decided by hard-to-predict factors such as swings in the global steel, electrode and needle-coke prices, Chinese output, global trade war dynamics, and India’s anti-dumping actions, its dividends can be prone to high volatility year to year, making it a poor choice for regular income seekers.

Companies with a five-year record of steady profit growth make for better dividend bets than those with a recent profit boom.

Price meltdown

Sometimes, companies pop up on high dividend-yield lists not because they paid out hefty dividends, but because their stock prices have fallen off a cliff. Given that the very purpose of dividend-yield investing is to earn a regular cash flow from a stable business, betting on a teetering business for yield is a dodgy strategy.

Apart from checking recent news, it is also critical to run a governance check on companies with an unusually high dividend yield before taking the plunge. In India, an ultra-low PE or a sky-high dividend yield on a stock is often a sign that the stock market is sceptical of the reported numbers.

There’s no point in investing in a ‘dividend yield’ candidate whose governance risks can decimate your wealth faster than dividend pay-outs can add to it.

Beverages-maker Manpasand Beverages seems to offer an attractive dividend yield of over 8 per cent, quite unusual in an FMCG stock. The company paid out dividends of ₹0.5-1 in the three years from FY16 to FY18, while its current market price is just ₹6.

But a check on its stock price chart shows a decline in its stock price from over ₹100 in May 2019 to ₹6 now. The company has been battling misgovernance and tax-fraud allegations and hasn’t published its financial results in recent quarters.

If you’re not in a position to gauge why a company’s stock price has plummeted so sharply, it is best to stay off dividend-yield plays with precipitous share-price drops. This is usually a sign that the market knows something about the business or its prospects that you don’t.

Promoter needs

In companies with a large or influential promoter, the promoter’s need for cash can exert a big influence on dividend policies.

They may vary their dividend payouts or take alternative routes to distribute surpluses, based on changing promoter requirements, making them unsuitable bets for regular income investors.

Despite its net profits rising sharply from ₹17,732 crore to ₹26,710 crore between FY15 and FY19, ONGC has trimmed its dividends to ₹7 per share from ₹9.5 in this period. The quantum of ONGC’s dividend payouts, like those of many other PSUs, has been driven by the Centre’s fiscal maths.

In the past couple of years, ONGC has been pressured by its promoter to buy out HPCL to help the disinvestment programme. It also distributed a chunk of its cash through buybacks.

While it may be hard to gauge if the promoter is pulling the strings on a company’s dividend policies, looking at trends in its dividend payout ratio in the past five years can be a good check on whether it is a regular or an erratic dividend-payer.

Companies that stick to a constant payout ratio or a tight range are the ones with a well thought-out dividend policy.

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Published on October 19, 2019
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