5 good dividend yield stocks that aren't traps

The recent stock market correction again underlined the utility of following value investing strategies, including shortlisting companies based on their dividend yields. While several companies with high valuations crumbled between January and March, the correction was limited in most high dividend yield entities.Even if companies reduce their losses, the dividend yield strategy still matters. High dividend paying companies have done well in the past year. Meanwhile, investors need to be extra careful because of the uncertainty in the economy. High valuation, even at the benchmark index level, should be a worry. For example, the forward PE of the Sensex is already above its value in January, when it was at an all time high.While it is a good strategy right now, dividend yield as a long-term strategy suits only some investors. “Dividend yield stocks are for investors who want to take lower risk and are ready to accept smaller returns for that,” says Mahesh Patil, CIO – Equities, Birla Sunlife MF. In other words, it is for investors who are ready to follow the ‘low risk and low return’ strategy. “This strategy will not outperform in extreme bull markets. But the downside is also limited because high yield acts as cushion during downside. So, it gives good risk adjusted return,” says Swati Prasad, Fund Manager, UTI MF.Investors should not think this strategy will eliminate risks. “People who follow dividend yield strategy should not assume that this strategy will make it risk free. After all, your investment is in equities and the risk will not go away,” says Ravi Gopalakrishnan, Head of Equities, Principal Mutual Fund. What it does is make the volatility bearable.Is dividend yield a trap?There is only a thin line between dividend yield and dividend trap because several companies that have given out good dividends in the past may not be able to do so in future. “Don’t look at dividend parameter alone. Investors need to consider other parameters also. Else, they may get into a dividend trap,” says Prasad. “You fall into the dividend trap when you concentrate only on dividend yield. Even if the company keeps paying dividend, you may end up losing money because the share price fall can be more than the dividend received by you,” says Sunil Damania, CIO, MarketsMojo.com. So, let us understand the steps you need to take to avoid a dividend trap.First, look at the consistency of dividend. “Consistency of dividend is more important than actual dividend. Make sure that the yield is calculated on regular and not one time dividend. Consistent dividend payout shows that company management is confident that it will be able to maintain profit,” says Gopalakrishnan of Principal Mutual Fund. You may fall into a dividend trap if you bet on stocks paying high dividends by selling their land, subsidiaries, etc and not from regular profits. Several companies had declared hefty dividends before 31 March 2020 due to tax law changes and the same is not going to be repeated in future. Therefore, stocks that we have identified are only companies that have declared dividends after 1 April 2020.Secondly, check whether the company will be able to maintain the dividend in future. This is important because the dividend yield is calculated based on historical dividend. “The assumption that last year’s dividend will be maintained this year may be faulty because profits of companies will come down significantly this year due to lockdowns and other economic disturbances,” says Damania.Investors need to be extra careful with companies from cyclical industries because they will have high cash flows during good times, but their cash flows go down once the cycle turns. This means the high dividend during good times may evaporate in bad times. So bet only on companies where the going is expected to be good in coming years. “Concentrate on companies where earnings are also expected to grow because the dividend will continue to grow then,” says Prasad. Continued growth rate is also needed for stock price performance. “Valuation multiples like PE will start collapsing once a company’s growth rate starts falling and this may result in higher capital loss,” says Damania.Third, check why the dividend is high. “Bet on companies that declare consistent dividends because they don’t need money to grow and not because they don’t have growth opportunities,” says Gopalakrishnan. You can identify this by looking at their growth rates and generation of free cash flow (FCF)—the cash companies earn after meeting capital expenditure also. “To sustain dividend, companies need to have positive FCF. Ideally, the FCF yield should be higher than dividend yield,” says Prasad.Fourth, check whether the current high dividend is justified. This can be checked by looking at the return ratios like return on equity, return on capital employed, etc. “Chance of companies paying high dividend in future increases if their return ratios like RoC, RoCE, etc are also high,” says Gopalakrishnan. Let us look at a few dividend yield stocks that are worth investing in now.CASTROL INDIA 77299490Castrol follows the calendar year and therefore, its final dividend for last year was declared before 31 March. However, it finds a place in this list as it paid interim dividend in June 2020. Though there is a small threat to its long-erm growth prospects—the need for lubricants may fall once vehicles move to electric from petrol and diesel, its fundamentals are very strong in other aspects. In addition to its cash balance of Rs 946 crore, Castrol also generated a FCF of `860 crore in 2019. Its RoE, which is placed at 65%, is a dream for most other companies.HPCL 77299496Continued fiscal needs of the government, the promoter, will be the main reason why this company will continue to declare dividends in future. HPCL made a 97% payout in 2019-20 and is maintaining it despite a fall in profit. Since the government is not forcing it to shoulder the oil subsidy burden, PSU oil companies have started generating good cash flows. Though the FCF turned negative in 2018-19 and 2019-20, HPCL is expected to get back to FCF positive in 2020-21 and its FCF yield is expected to be around 14% in 2020-21. This means there is high probability that HPCL will increase its dividend rate once again. HPCL also moved to a low tax regime because its accumulated MAT credit is already over.ITC 77299506ITC is another fundamentally strong company that faces growth challenges in its core field—cigarettes—due to regulatory issues. However, it is overcoming this by investing in other FMCG growth segments like food. While other industries struggled during the lockdown, the packaged foods industry did well and this trend is expected to continue. To cash in on increased concerns over health and hygiene, ITC has launched products like surface disinfectant spray, fruit & vegetable wash, etc recently. Since most of its capital expenditures are complete, its cash pile (Rs 7,277 crore as on 31 March) and FCF (Rs 11,693 cr in 2019-20) are expected to increase in future. Maintaining higher dividends in coming years won’t be a problem for ITC.PETRONET LNG 77299510Petronet is in a sweet spot now because it is both a dividend yield and a growth stock. Petronet’s long term outlook is bright because it will benefit most from India’s ever increasing demand for natural gas, triggered mostly because natural gas is cheap and it is less polluting. Gail India is expected to commission the Kochi – Mangalore gas pipeline in August and this will help Petronet to improve its utilisation levels at its Kochi terminal and to show higher volume growth during the second half of 2020-21. This can provide an immediate trigger for the counter. Since it has a cash pile of Rs 4,400 crore now, there is a high chance that Petronet will be able to maintain its high payout ratios.TATA POWER 77299520Just like ITC, Tata Power is also reinventing its business model due to regulatory and environment issues. For example, Tata Power is now moving away from coal based power plants, which are facing environmental hurdles, and going green by concentrating on clean energies. It will increase the clean energy mix from around 30% now to 50% in five years. It also wants to increase retail revenues by offering consumers items like rooftop solar power generation, solar pumps, electrical vehicle charging, micro grids, home automation, etc. Once the ongoing debt reduction plan is complete, Tata Power should be able to increase its dividend payout ratio, which is placed only around 32%.Should you take the mutual fund route for dividend yield?Investors can also follow the dividend yield strategy by taking the mutual fund route. Several equity schemes follow this strategy (see table). However, the weakness of the strategy applies here as well. Since all schemes here follow a basic criterion—dividend yield of portfolio stocks should be more than the dividend yield of broader market—the stock universe for these schemes is quite limited. Dividend yield funds suit investors with low risk appetiteThese schemes have underperformed in bull markets but did quite well during last year’s volatility 77299558 77299564“Dividend yield is a function of market price as well and therefore, stocks from some high-priced growth sectors will always be out of the dividend yield universe,” says Swati Prasad, Fund Manager, UTI Mutual Fund. In other words, there may not be enough quality dividend yield stocks available at all times. Some fund houses try to manage this problem with international diversifi cation. “We also look at international markets and invest in high quality stocks, which offer high dividend yield and growth,” says Mahesh Patil, CIO– Equities, Birla Sunlife mutual fund.

from Economic Times https://ift.tt/33ofENZ