Friday, August 14, 2009

Investment Prudence: Dividend Paying Stocks

Before I begin with, I would like to thank all the readers for their support. The Blog now has more than 100 readers which I am happy about. I am unable to post more articles these days as my work does not leave much scope to do so. But I will try my best to share my opinions whenever I have time and something in my mind as well.

Investors follow many different approaches towards investment and this post is for the investors who would like to preserve the capital first and gets satisfied with decent return through capital gains. In fact many legendary investors have followed this strategy and they have been mostly successful. Yes. I am talking about investing in the “high dividend paying stocks”.

What is Dividend?

It’s the portion of corporate profit paid to shareholders by a company. High dividend yielding stocks usually have high reputation among defensive investors. It’s widely believed that a company is effectively managed if the shareholders are paid dividends continuously.



Approach

The notion that high dividend yielding stocks do not appreciate much is not entirely true at least if we look at the stocks I have mentioned below. All of these stocks performed well over the year apart from paying out decent dividend yields.

Madras Cement
Graphite India
Varun Shipping
GE Shipping
Ambuja Cements
MIRC Electronics
Chambal Fertilizers
HCL Technologies
Tata Steel
Tata Tea
Lakshmi Machine Works
Shipping Corporation
GAIL India Ltd
Sesa Goa
Canara Bank
Bank of Baroda
Punjab National Bank
Hindustan Unilever Ltd
Marico Ltd
Indian Overseas Bank

If you are a long term investor and do not have high appetite for risk, then investing in the “high dividend” yielding stocks not only protects part of your capital but also gives you decent return. I will explain with an example.

Ex: Varun Shipping

Assume that you bought 1000 shares of Varun Shipping at Rs. 40 / share. Total investment comes out to be about 40000 thousand rupees. Assume that you are a long term investor and have plans to hold the stock for next five years. Varun Shipping has the history of paying Rs. 5 – 6 per share as a dividend (50 % of the face value) every year and we assume Rs. 5 / year as the dividend for next 5 years.

First Year Dividend: Rs. 5 / share (Rs. 5000 / 1000 shares). The dividend yield itself is 12.5%. Even if your Cost price was Rs.50 per share, the dividend yield would be 10 % which some stocks do not even give as a capital gain. Suppose you deposit this Rs. 5000 in a bank and you get 7% as interest. You get Rs.350 as interest and the total amount for the first year is Rs.5350.

Second Year Dividend: Rs. 5 / share (Rs. 5000 / 1000 shares). Add this amount with the first year amount. Rs. 5000 + Rs. 5350 = Rs. 10350. Interest at 7% for Rs. 10350 is Rs. 725 and the total amount at the end of second year is Rs. 11075.

Third Year Dividend: Rs. 5 / Share. Do the same calculation. Rs. 11075 + Rs. 5000 = Rs. 16075. Interest at 7% for Rs. 16075 = 1125. Total amount at the end of Third year = Rs.17200.

If we follow the same calculation, we will have Rs. 31000 after 5 years which is 78% of your initial capital investment. This will go along with the capital gains that you get because of appreciation in stock value. If we assume that Varun Shipping matches the market performance which is around 15% CAGR, then we will have Rs. 81000 after 5 years and adding that with dividend + interest income will give Rs. 112000 as the total value of the investment after 5 years. The calculation is based on a conservative approach which gives 180 % return. But if the stock performs better than the market, then the return might well go above 200 % which should make most of the investors happy.

Similar stocks are available with similar dividend yield and investors with less risk appetite may opt for these kinds of stocks and follow the above explained strategy. In fact most of the stocks I mentioned above have performed better than the market and some are even in the aggressive investor’s portfolio. So, we just need to try this approach once to see the effectiveness.

Kumaran Seenivasan
http://www.stockanalysisonline.com/

6 comments:

Anonymous,  August 15, 2009 at 1:27 AM  

Kumaran -
Thank you very much for your articles. I was a big zero in the financial sector. With the help of your simple and informative articles, now I am quite familiar with some of the technical terms and concepts.
Thanks
Roshan

Kumaran August 15, 2009 at 8:40 AM  

Thanks for your comments Roshan.

-Kumaran.

Anonymous,  August 17, 2009 at 10:25 AM  

HI
thanks for your informative article. This approach is good for conservative investors. One will get tax free dividents along with appreciation in stock price. thanx

radha February 22, 2010 at 2:06 AM  

thanks for your valuable information. radha

Anonymous,  December 4, 2010 at 5:01 PM  

Great post, I am almost 100% in agreement with you

dividend paying stocks May 9, 2011 at 4:11 AM  

Hi, Your blog has been impressive and would like to follow them closely going forward.

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