I have been reading a few reports that advise investors to buy companies based on dividend yield. My advice is to apply abundant caution. One should never buy companies based on one criterion. There is a high probability that you may get stuck with weak performing companies for an extended period.

As an investor, you should not buy stock for dividend yield but capital gains. If someone is interested in the fixed kind of returns in the form of a dividend, then fixed income instruments are much better as you know the exact amount you receive every year. Dividend incomes are volatile. Second, India’s dividend yield (Sensex) in the last 14 years is in the region of 1.92 percent to 0.85 percent. There are many other emerging markets where dividend yields are much higher. Hence the Indian stock market has never been known for dividend yield but capital gains. I can give you examples after example where companies did not pay a dividend but offered excellent capital appreciation. Let us take Avenue Supermarts- one of the best-performing stocks since its listing but did not declare any dividend to public shareholders. Bharti Airtel gave maximum returns to the investor among Nifty 50 companies in the last year, even though it skipped dividends last year.

Now let me take a few examples of companies that lure you with higher dividend but performed poorly on the bourses. This holds for most of the PSU stocks but applies to the private sector too. Take the case of FMCG player Bajaj Consumer Care which is a good dividend yield stock but lost 58 percent of its market cap in the last one year. Take another company DB Corp offering a dividend yield of almost 12 percent but in the last one year lost 55 percent market cap. In that sense, what you gained in dividends but lost five times more in capital losses! As per the MarketsMojo score, these two companies are not worth adding in the portfolio.

Also, there is a flaw in terms of calculating the dividend yield. Reports are assuming that the company will maintain the same dividend per share in the future too. Coronavirus has put the world economy in the tailspin. In CY2020 world economy will be in recession. India will be among the fastest-growing big economies, but the rate of growth will fall sharply. Many experts have scaled-down India’s GDP growth rate to 2-3 percent as compared to projected 6.1percent for FY21. Even a 2-3 percent growth rate is under danger of being revised downward as the Modi government has announced the extension of lockdown till 3rd May.

The slowing domestic economy, coupled with a recession in the world, will have a significant impact on the India Inc. earnings. In the next 9-12 months, many corporates will try to preserve cash during uncertain times. Due to that, the dividend payout will be the casualty.

Based on the historical dividend payout, the company may look attractive, but future flow may not be that robust. Hence your expectation of higher dividend may go kaput. Second, many companies in the last two months declared dividends due to the change provision for tax on dividends in the budget. Hence next dividend, if any, is almost 12 months away. Usually, July and August are the dividend season due to shareholders approval taken in AGM. But this time, that may not be the case.

Hence, I sincerely advise not to buy a company purely based on the dividend yield criterion. Look at the quality of the company and business environment to understand whether the company can maintain a higher dividend or not. Also, look at how the company’s share price likely to perform in the next 12 months. At Marketsmojo, we look at the dividend yield while looking at the valuation of the company. Any company offering yield more than 50 percent of 10-year GSEC is eligible for an upgrade but not necessarily buy. As explained, both D B Corp and Bajaj Consumer are “sell” as per our score even though they score high on dividend yield.

In case you wish to buy companies, please follow our score-based approach, which takes into consideration various fundamental, sectoral, and technical factors. This is a more holistic approach to purchase stocks. Remember it’s your hard-earned money which needs special attention. Taking short cuts like a single factor like dividend yield will invariably make your portfolio underperform.

Sunil Damania
Chief Investment Officer