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How to play the dividend yield strategy in a rising stock market

Most long term investors favour this strategy because betting on high dividend yield stocks ensures a regular stream of income for investors.

, ET Bureau|
Jul 03, 2017, 06.30 AM IST
In this rising market, you can find value in dividend-paying companies. But you need to pick the right stocks first.
In this rising market, you can find value in dividend-paying companies. But you need to pick the right stocks first.
High market levels and the resultant high valuations are the primary concerns of stock market investors now. Should they stay out of the market, or try to get into the segments that are not heavily overvalued?

Experts suggest that investors should opt for the latter. Of the various value-investing strategies, the dividend yield strategy is the most suitable one now because most companies have already declared final dividends or are in the process of doing so.

Most long term investors favour this strategy because betting on high dividend yield stocks ensures a regular stream of income for investors.

Bear in mind though, the dividend yield varies in accordance with the market conditions. “In a bear market, a yield of 5-6% can be considered good while in bull market, like the one we are in, the dividend yield should be at least 2-3%,” says Upendra Kulkarni, Executive Director, Fortress Financial Services

Pick companies that pay dividends regularly
Don’t ignore the growth prospects of a company. The stock price movement depends on the firm’s growth prospects.
How to play the dividend yield strategy in a rising stock market
Don’t treat dividend yield strategy as a short-term trading tactic.
Source: ETIG; Sorted on the basis of dividend yield

Factors to consider besides yield
While everyone fancies getting hefty dividend payouts, investors need to keep several factors in mind when playing the dividend yield strategy. First, don’t think of it as a short-term trading tactic. The share price corrects after the dividend payout, limiting the chances of any real gain from dividend stripping—selling the stock just after you receive the dividend. “Investors should hold these shares for long term and not treat dividend yield strategy as a short-term play,” says K. Subramanyam, Co-Head, Equity Advisory, Altamont Capital.

Second, just because you are looking at dividend payouts, you should not ignore the growth prospects of a company—the stock price movement depends on the company’s growth prospects. This will prevent erosion in your invested capital. “PSU banking stocks had a good dividend yield earlier, but they are not as attractive now because of their NPA issues and also due to concerns surrounding their growth,” says Subramanyam.

Third, understand the limitation of the dividend yield strategy. “Dividend yield is calculated based on historical dividends and, therefore, the yield (stated as a percentage of the share price) may look good if the stock price is down due to some reason. Investors need to consider the reasons behind the price fall,” says Kulkarni. Noida Toll Bridge Company is a case in point. It had a steady business model and a track record of high dividend, but its entire business model came under the cloud after the Allahabad High Court barred it from collecting toll from commuters moving on the Delhi-Noida-Direct (DND) flyway.

Fourth, high dividend yields should not be based on one-off ‘special dividends’. For example, some of the high dividend yield companies— Vedanta, Hindustan Zinc—make the list because of special dividends. “Instead of chasing high yield due to special dividends, investors should focus on companies that give recurring high dividends,” says Subramanyam. Coal India is an example of companies that have been declaring high dividends consistently.

Sectors that hold promise
The dividend yielding sectors often change and investors need to shift their holdings accordingly. For example, the IT sector is slowly changing its colour from being a growthoriented sector to being a dividend play. The dividend yields from some stocks from the IT sector are above 2% and can be included in one’s dividend yield strategy.

For example the yield is placed at 2.78% for Infosys and 2.04% for TCS. Most IT companies are expected to give handsome dividends in the coming years as well. This is because the sector’s growth rates have come down but IT companies are sitting on a huge pile of cash. However, it is important that you pick the market leaders within the sector. “Investors need to restrict themselves to frontline companies from the IT sector because of the overall growth concern the sector faces,” says Kulkarni.

Infosys seems to be a particularly good bet because it has already announced that it will pay out $2 billion— around Rs 13,000 crore—in 2017-18 to share holders in the form of dividends or share buybacks. The oil and gas sector is another segment that is becoming a good dividend yield play. Public sector oil companies like Chennai Petro and HPCL are already in the top 10 dividend paying companies. Oil PSUs should continue to declare good dividends because the government wants money from them to plug its fiscal deficit.

Due to the stable crude oil prices, this sector prospects are also improving. Investors can now also bet on blue chip MNCs for dividends. “Indian subsidiaries of MNCs are becoming a good dividend yield play now because their parent companies are looking for dividends,” says Kulkarni. Finally, be careful when it comes to the quality of the stocks you invest in. Avoid poor companies and stick with quality stocks for the long term. “Since the market is already at elevated levels and is ripe for correction, investors should not compromise on quality. If the stock is fundamentally strong, it will bounce back after the initial crash,” says Kulkarni.

Also Read

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Using dividend yields to pick stocks

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