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Indian Market Review from Keynote Capitals: Low Dividend Yield Stocks

Both in bull and bear markets, a large number of investors seek out high dividend yield stocks, as the latter apparently provide returns similar to that on say fixed deposits with banks. Most investors view high dividend yield stocks as safe bets. However, investors tend to overlook the fact that the primary objective of equity investments is capital gains, rather than fixed returns.

We conducted a study in order to understand the market’s perception of high dividend yield and low dividend yield stocks and arrived at the following conclusions.

Summary of findings

- Aggregate earnings growth: Remarkably, low yield stocks reported a higher average earnings growth y-o-y (65% in FY07 and 37.5% in FY08) vis-?-vis high yield stocks (30.5% in FY07 and 14.9% in FY08).

- Aggregate market cap changes: High yield stocks (down 32.5%) however outperformed low yield stocks (down 32.9%) during the period under consideration.

- Dividend payout: High yield stocks reported higher payout of 35.4%, while the payout of low yield stocks was far lower at 11.8%.

- Sector prospects: Stocks from emerging and high growth sectors offered low yield, while stocks from sectors with low to moderate growth offered high yield.

- Average yield: High yield stocks had an average yield of 4.3% and low yield stocks, 0.5%

- Safe bets? If profit growth in high yield stocks is indeed lagging that in low yield stocks, can the former really be considered “safe bets”? We believe slower profit growth may indicate a lower probability of dividend percentage and payout being maintained going forward, failing which the yield could decline, making these stocks “less attractive” than they appear currently.

Conclusion

We therefore conclude that high yield stocks may not necessarily be safe bets after all, especially as they most probably belong to low-to-moderate growth companies, while it is the low yield stocks that could actually have a higher likelihood of giving better returns, by virtue of belonging to moderate-to-high growth sectors.