Mak­ing div­i­dends work for you

The Pak Banker - - OPINION - Vikas Gupta

We had ear­lier dis­cussed a strat­egy about how high qual­ity com­pa­nies with a div­i­dend yield of 2% or more could be used to build wealth and form a grow­ing in­come stream for re­tire­ment years. The hy­po­thet­i­cal cal­cu­la­tion showed that Rs.10 lakh in­vested in such a port­fo­lio would end up in a cor­pus of Rs.40 lakh and an ini­tial in­come stream from div­i­dends of Rs.20,000 per year, grow­ing to an in­come stream of Rs.80,000 at the end of 10 years.

The as­sump­tion was that this Graham-and-Buf­fettsville port­fo­lio was in­vested in 20-30 com­pa­nies with re­turn on eq­uity (ROE) of 25% and avail­able at a price such that the div­i­dend yield was 2%. These cri­te­ria might seem too strin­gent to some and they might think that this is not prac­ti­cal or re­al­is­tic. While strin­gent, as any Graham-and-Buf­fettsville idea is, this is in­deed a prac­ti­cal, and quite a re­al­is­tic, idea.

We started out with a uni­verse of all the listed com­pa­nies and se­lected rel­a­tively large-sized busi­nesses, of Rs.500-1,000 crore and above. Then we ap­plied a cri­te­ria of re­turn on eq­uity (ROE) be­ing more than 25% and div­i­dend yield be­ing more than 2%. Anal­y­sis pe­riod was Jan­uary 2003 to June 2015. The to­tal re­turn of this port­fo­lio was 33.9% com­pounded an­nual growth rate (CAGR) over the pe­riod. Nifty re­turned 19.5% CAGR for the same pe­riod. The price re­turn-the re­turn ex­clud­ing div­i­dends-was 29.8%. This means that Rs.10 lakh in­vested in this strat­egy would have be­come Rs.2.6 crore. (In com­par­i­son, our con­ser­va­tive cal­cu­la­tion showed an ex­pec­ta­tion of Rs.40 lakh. Even a Nifty in­vest­ment would have beaten that with Rs.10 lakh hav­ing grown to Rs.78 lakh.)

The div­i­dend yield at the time of in­vest­ing in the port­fo­lio in 2003 was 4.8% and at the end in 2014, it was 3.8%. The rupee pay­outs would have started out at Rs.48,000 in 2003 (against the con­ser­va­tive ex­pec­ta­tion of Rs.20,000) and would have been nearly Rs.10 lakh in 2015 (against the con­ser­va­tive ex­pec­ta­tion of Rs.80,000). While the div­i­dend re­sults are quite ro­bust, one should keep in mind that it is af­ter all an eq­uity in­vest­ment and, hence, risky. The port­fo­lio val­ues would have fluc­tu­ated. In 2008-09, it would have dropped as the mar­ket dropped. How­ever, the drop would have been much less than in Nifty. The in­dex's worst 1-year drop was 55% while the port­fo­lio dropped 34%. So, the strat­egy also makes the port­fo­lio in­her­ently more sta­ble than the over­all eq­uity mar­ket. Over a long term of five years or more, this works out to be a very sta­ble strat­egy.

Now, sup­pose, you had only ap­plied the cri­te­ria at the be­gin­ning of 2005 and then for­got­ten to re­bal­ance, i.e., let the port­fo­lio be a typ­i­cal (War­ren) Buf­fett "buy-and-hold" (or rather a "buy-and-for­get" port­fo­lio). That port­fo­lio would still turn your Rs.10 lakh to Rs.63 lakh with a 19.2% CAGR over the pe­riod, beat­ing Nifty's Rs.48 lakh re­turns at 14.6% CAGR. In ad­di­tion, you would have re­ceived div­i­dend pay­outs start­ing at Rs.38,000 in 2005 to Rs.69,000 in 2015. Now, let us put the strat­egy to a more strin­gent test. Say, you had ap­plied the cri­te­ria in Jan­uary 2008 at the peak of the mar­kets. Would you have been able to se­lect any com­pa­nies us­ing this cri­te­ria? Yes, you would have found 15 com­pa­nies. As­sum­ing that you for­got to re­bal­ance the port­fo­lio, your Rs.10 lakh would have still turned into Rs.34 lakh over the pe­riod of 2008-15 with a CAGR of 17.9%. But the Nifty would have re­turned Rs.13.3 lakh, which is a CAGR of 4.4%. In ad­di­tion, the div­i­dend for the 2008 port­fo­lio would have been Rs.26,000, and nearly Rs.45,000 in 2015.

But which are these com­pa­nies that you would have been able to se­lect with this cri­te­ria? Prob­a­bly, some com­pletely un­known names? No. A ma­jor­ity of the com­pa­nies were the top names in their sec­tors and are dar­lings of the mar­kets to­day. These were well-es­tab­lished busi­nesses of sub­stan­tial size and recog­ni­tion in 2008 as well, and most had been op­er­at­ing in In­dia for decades. There were at least four well known fast-mov­ing con­sumer goods (FMCG) com­pa­nies; some were from the in­for­ma­tion tech­nol­ogy sec­tor; a two-wheeler man­u­fac­turer; an oil and gas public sec­tor com­pany; one petrochem ma­jor; and oth­ers from in­dus­trial sec­tors. While two com­pa­nies were bad picks and lost sig­nif­i­cant money, and one gave a mid­dling per­for­mance, the re­main­ing 12 have been multi­bag­gers (rang­ing from two bag­gers to nine bag­gers). Many of these were rec­og­niz­able names and prac­ti­cally all are to­day con­sid­ered "high qual­ity" Buf­fett-like com­pa­nies. How­ever, the fact that such amaz­ing names were avail­able as value-buys for a div­i­dend gen­er­at­ing port­fo­lio speaks on how pow­er­ful the cri­te­ria is. In short, not only is it pos­si­ble to cre­ate a high and grow­ing div­i­dend port­fo­lio of stocks that can pro­vide a grow­ing in­come stream, it is also pos­si­ble to grow one's prin­ci­pal sig­nif­i­cantly. What looks like a low-risk con­ser­va­tive re­tire­ment strat­egy is ac­tu­ally a very ag­gres­sive-on­re­turns strat­egy beat­ing ma­jor­ity of the mar­ket par­tic­i­pants (prob­a­bly, all the mu­tual funds in In­dia), and is able to mul­ti­ply your cap­i­tal 3-26 times depend­ing on whether you re­mem­bered to re­bal­ance it and how many years you gave it to mul­ti­ply.

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