Thursday 31 May 2012

Investing for Dividend Yield



“Sales is Vanity, Profit is Sanity & cash is Reality” – Anonymous


The quote above has been a backdrop of the dividend yield theme. Investing for dividends is a philosophy in itself. Lot of us believe that to make money in stock markets one should invest in great businesses with equally great management. The rationale behind great management is prudent use of capital. We all focus on profits and growth in profits of a company while very little time is spent on finding how much cash is generated out of profits and what the end use of this cash is.


Let’s take Nestle India as a case in point. It is in existence since many decades in India and is one of the most innovative companies in terms of product launches and has a near dominant position across product ranges. Nestle has been the most prudent user of capital for many decades. In the last 10 years they have grown sales from 1900 crores to 7500 crores at a CAGR of 16.15%. PAT has grown from 200 Crores to 960 crores at a CAGR of 19%. In the last 10 financial years it has made a total after tax profit of 4700 crores. Nestle has paid 3200 crores as dividend which is about 68% of their total profit of 4700 crores. Nestle shareholders have been rewarded handsomely by getting 64% of  their capital back in the form of dividends while the stock price has multiplied from Rs. 520 in 2002 to CMP of Rs. 4500.


We can find great businesses with great management around various sectors in India like Auto, Auto Ancillary, Chemicals, Engineering, Consumption and Banking. The mindset of most of the investors in India in the era 1975 to 1990 was to constantly invest in businesses which made prudent use of capital and gave regular dividend to investors. Dividend yield was a powerful concept way back then because capital was scarcely available.


In the year 1991 when the doors to liberalization were opened for foreign capital and competition capital became available more easily. The focus then shifted from prudent use of capital to rapid growth by using financial leverage. As the cost of capital started decreasing companies started showing higher ROCE (Return on capital employed) along with rapid expansion in profit. As India moved to 8% plus GDP growth the focus of investors too shifted from dividend paying companies to high growth companies.


In the year 2010 as the cycle started turning again, the cost of capital started increasing and capital became scarcer. Focus shifted back to cash flow generating business and in the last two years we have seen re-rating in all the cash flow generating businesses with high quality management.


Mutual funds in India started launching dividend yield funds way back in 2003. They didn’t get enough recognition from 2003 – 2007 where capital cost was going down and GDP was witnessing rapid growth. Since 2008 the dividend yield theme started getting focus wherein such funds have delivered positive returns since the peak of 2008 whereas for the same period the index is down by more than 25%.


As we speak the dollar has depreciated by more than 25% in last one year. This will have an inflationary impact with the result that the cost of capital may go up sharply. In this high inflationary environment dividend yield stocks will benefit most because of their healthy balance sheet, good management and gradual easing off of competitive pressures. For investors who have been in the market for a long time and have tracked management and businesses closely they will have the necessary know-how to cherry pick such stocks. For beginners or novice investors Dividend Yield Funds offer a good investment vehicle to participate in high quality cash flow generating business. 

Performance as on May 29, 2012

Compound Annualized
Scheme Name
1 Year
2 Years
3 Years
5 Years
BNP Paribas Dividend Yield Fund - Growth
-3.02
3.51
15.02
8.71





Indices




S&P Nifty
-8.81
-0.76
3.90
3.05