High dividend paying companies have performed well in the last one year. During January-March, where many companies with high valuations collapsed. At the same time, this decline was limited in most of the companies paying more dividend. However, given the uncertainty in the economy, investors need to be extra careful.
By the way, the dividend yield strategy is right now. But, in the long run, it suits only a few investors. Mahesh Patil, CIO-Equities, Birla Sunlife Mutual Fund says dividend yield stocks are for investors who want to take less risk. One should be prepared to be satisfied with diminishing returns.
In other words, it is for those investors who are following the 'low risk, low return' strategy. Swati Kulkarni, Fund Manager, UTI Mutual Fund, says that this strategy will not give very good returns during the bull market. But, the decline in this will be limited. The reason is that the high yield will act as a cushion during the fall. In this way, this strategy gives good risk adjusted returns.
However, investors should not be under the impression that this strategy eliminates the risk. Ravi Gopalakrishnan, Head of Equities, Principal Mutual Fund says investors following the dividend yield strategy should not assume that it is risk free. After all, your investment is in equity. So the risk will not be gone.
Is there a dividend yield trap somewhere?
There is a very fine line between dividend yield and dividend trap. Many companies that have given good dividend before may not be able to do so in future. Swati says that one should not look at the scale of the dividend alone. Investors need to see more scale. Otherwise, they may fall into the dividend trap.
Sunil Damania, CIO, Marketmojo.com, says that if you only look at the dividend yield, then you can get caught in the dividend trap. Even if the company continues to pay dividends, you may end up losing money. The reason is that the fall in the share price can be more than the dividend received. In such a situation, to avoid this, you have to understand some things.
First, look at the dividend consistency. Gopalakrishnan says that the consistency of the dividend is more important than the actual dividend. Regular payment of dividend shows that the company's management is confident that it will maintain profits. Many companies had paid huge dividends before 31 March 2020 due to changes in tax laws. They might not be able to do this in future. Therefore, we have identified only those stocks which have declared dividend after April 1, 2020.
Second, check whether the company will be able to pay dividend in future also. The reason is that the dividend yield is calculated on the basis of historical dividend. Investors need to be more cautious about industry companies doing well in a given cycle. The reason is that their cash flow will be strong in good times. At the same time, on changing the cycle, the cash flow will suddenly come down. This means that the great dividend paid in good times will be lost in bad times. So bet only on those companies which have the potential to do well in the future as well.
Third, see why dividends are high. Gopalakrishnan says that bet only on companies that pay dividends continuously. For this, their growth rate and free cash flow (FCF) can be seen.
Fourth, check if the current high dividend is reasonable. To find this out, return ratios like Return on Equity, Return on Capital Employed can be seen. Let us now look at some dividend yield stocks that can be invested now.
1. Castrol India
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Castrol operates on a calendar year basis. Therefore, its final dividend for last year was declared before March 31. This stock has been included in our list because it has paid interim dividend in June 2020. However, there are some concerns about its long-term growth. But, the other side is very strong. Apart from cash balance of Rs 946 crore, it has also generated FCF of Rs 860 crore in 2019. Its return on equity is 65 per cent which is a dream for most companies.
2. HPCL
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The promoter of this company is the Government of India. The government will need money to meet the fiscal needs. Therefore the company will continue to pay dividend in future. HPCL had paid 97 per cent in 2019-20. Despite the decline in profits, the company has maintained it. Since, the government is not forcibly putting the burden of oil subsidy. That's why government oil companies have started generating good cash flow. By the way, the FCF of HPCL became negative in 2018-19 and 2019-20. But, there is a possibility of FCF turning positive again in 2020-21. In 2020-21, the FCF yield may reach around 14 percent. This means that HPCL can increase the dividend rate again.
3. ITC
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It is fundamentally another strong company. It is facing the challenges of growth in its core field (cigarettes). However, to meet this challenge, it is investing in FMCG growth segments like food. Where other industries struggled in the lockdown. At the same time, the performance of the packaged food industry was good during this period. To take advantage of the increased hygiene and health concerns, ITC has launched products like Surface Disinfectant Spray, Fruit and Vegetable Wash. Its cash balance as on March 31 was Rs 7,277 crore. At the same time, FCF till 2019-20 was Rs 11,693 crore. It is expected to grow further. Therefore, it will not be a big problem for the company to maintain high dividend in the coming years.
4. Petronet LNG
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Petronet is in very good shape right now. The reason is that it is both a dividend yield and a growth stock. The company's long-term outlook is excellent. It will benefit from increasing demand for natural gas. Its demand is bound to increase. It is cheap and does not pollute. It has a cash balance of Rs 4,400 crore. Hence it will keep paying higher dividends.
5. Tata Power
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Like ITC, Tata Power is also rediscovering many things in its business model. This is because of environmental issues and regulatory restrictions. For example, Tata Power is now moving from coal based power plants to clean energy. It has made remarkable progress in this direction in the last five years. It wants to increase retail revenue by offering consumer items like rooftop solar power generation, solar pump, electrical vehicle charging, micro grid, home automation. Right now the emphasis of the company is on reducing karma. If this plan is implemented, the company can increase its dividend payout ratio.
