Investments in equities fetch returns in two forms. One is capital appreciation and the other is dividend. In a high growth economy like India, the focus of most investors tends to be on capital appreciation. They do not pay much attention to dividends. This is a mistake. Dividends play a key role in the valuation of a company. In value investing, dividend yield is a key parameter which determines whether a stock is attractive. It has been observed that a company which has high dividend yield is expected to contain downside for investors in comparison with a company which has low or no dividend yield. A company’s dividend yield is calculated by dividing dividend per share paid by the company by its share price.
Dividends paid over a time add up and meaningfully reward investors. Over 20 years ended July 24, 2020, the Nifty 50 index has delivered 11.16% returns. In the same period, the Nifty 50 TRI – the total return version which accounts for dividends earned over these years–has given 12.85%. This gap of 168 basis points in returns is the power of dividends.
Dividends do not lie. They are cash payouts made by corporations. Hence, value investors place high importance to dividends over all other metrics to value a company. But investors must check the consistency in dividend payout. Investors should consider special dividends and not ignore growth in earnings after ascertaining the sustainable rate of dividends. This helps to avoid value traps.
Growth investing has definitely beaten the value investing in the past ten years. Read Growth At Reasonable Price. However, the mean reversion theory makes a strong case for value investing to come back. As we move into a turbulent phase of low economic growth and disruption, the importance and value of dividend investing will increase and it will become a prominent theme among savvy investors. Consistent dividend paying companies typically are cash machines and have low or no loans on their balance sheet. Such lean balance sheets are of great advantage when a sector’s growth is low or even shrinking. Such companies are more likely to survive over those that require more capital to grow. In India most consistent dividend paying companies include companies that come from Fast Moving Consumer Goods (FMCG) and healthcare sectors. Companies in these two sectors are relatively placed well to weather the current challenging time. Hence, investors may look at dividend investing as a part of their defensive portfolio.
Selecting stocks based on dividend yield helps contain the downside in a portfolio’s returns. It also helps investors in achieving steady compounding of returns in the long term. The Nifty Dividend Opportunities 50 TRI has delivered 8.5% returns in the past ten years compared with 8.85% returns given by the Nifty 50 TRI index. This shows that you gain enough when you chase dividends and in the long-term dividend-focused investing works.
In the context of these facts, first-time or retail investors who are unable to identify high dividend yield stocks or may not have the time to do so may consider investing in dividend yield mutual funds schemes. In the past ten years actively managed dividend yield funds have delivered 8% returns compared with 9.02% returns given by multi-cap schemes. Investors can also take passive exposure by investing in index funds.