Dividend Yield Funds

During a bull run, it’s very easy to ignore stocks with high dividend yields. After all, what could be more enticing than a growth stock? But in times of crisis, these boring ones tend to be the most sought after. The reason being that not only do dividends provide a cushion when the market is in the doldrums but such stocks also tend to fall less.

The lure of dividend yield stocks is not easy to ignore. These stocks offer capital appreciation as well as cash payments. But logically, any company that pays a substantial portion of its earnings in dividends is reinvesting less and, therefore, would grow at a slower pace. So the trade-off is between higher dividend yields for lower earnings growth.

On the other hand, companies with high growth potential and volatile earnings tend to pay less by way of dividends, if at all. Such companies would rather reinvest their earnings to sustain their growth. The capital appreciation of growth stocks is obviously higher than in dividend yield ones.

But it does not mean that every single stock that pays dividends is a worthwhile pick. Yes, high dividend yield stocks tend to be cash rich companies. After all, only those companies which are financially healthy can pay consistent dividends. But there could be some high dividend yield stocks that may be paying much more than they can afford.

So it would only be a matter of time before the dividends are cut. Or, it could also be that the dividend yield is up because the stock price has got hammered and not because dividends have risen.

Dividend yield is a function of the amount a company pays out over the trailing 12-months period divided by its share price. So if a company pays Rs 10 as annual divided and its share price is currently Rs 100, the dividend yield is 10 per cent. Yield, obviously, can fluctuate if a share price moves up or down or if the dividend amount increases or decreases. The trick is to find companies, which tend to generate lot of cash with modest, but steady growth.

Brokerage firm India Infoline conducted a study on dividend yield stocks in August 2008. Using a screening methodology to ensure that the results were not skewed towards small-cap stocks and to even out the risk-reward in the selection, they narrowed down on 25 companies from the BSE 500. These companies had dividend yields ranging from 3.5 per cent (Tata Motors) to 8.9 per cent (Bongaigaon Refinery).

According to the study, 14 companies were stable dividend payers, but to a great extent aided by the strong economic growth in the last few years. While 15 of them reported a significant YoY decline in profits in the latest quarter (April-June, 2008).

Investors need to study prospects and fundamentals of a company before taking any investment call, including dividend yield stocks. As dividend yield is based on the past performance, it is hardly an indication of the future profitability and sustainability of dividend. Investors must look at growth potential, quality of management, industry prospects and macro issues. For instance, given the current economic scenario, it would be wise to avoid companies with high debt or large capex plans even if the dividend yields are attractive.

One option for investors looking at such stocks would be to consider dividend yield funds. Here too the criteria would be the same. A good dividend yield fund would be one that does not focus solely on stocks with the highest dividend yield but aims at finding the best overall investments.

Typically, a dividend yield scheme would predominantly invest majority of its assets in a well-diversified portfolio of companies with relatively high dividend yield, which provides a steady stream of cash flows by way of dividend. Thus, dividends received from these companies are earnings for the scheme.

If you take a look at the six dividend yield funds available, what comes across is their own interpretation of what makes a stock a ‘high dividend yield’ one. Some are very specific, others are not (see: Each To Its Own).

EACH ON ITS OWN
Fund Allocation to High Dividend Yield Stocks (min-max)
Birla Sun Life Dividend Yield Plus 65% - 100%
Fortis Dividend Yield 65% - 100%
ING Dividend Yield 65% - 100%
Principal Dividend Yield 65% - 100%
Tata Dividend Yield 70% - 100%
UTI Dividend Yield 65% - 100%


While we have looked at all of them, three funds stand out. These are the ones that have been consistently appearing in the top performing list as equity funds continue to plummet. It’s not that the Net Asset Values (NAVs) of Birla Sun Life Dividend Yield Plus, ING Dividend Yield and UTI Dividend Yield have not fallen. It’s just that they are amongst the least unfortunate (in terms of 1-year returns).

However, all of them do not appear in the following analysis. We have looked at UTI Dividend Yield, Tata Dividend Yield and Birla Sun Life Dividend Yield Plus. Over time, these have proven to be the better bets.



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