Beating the bears
Investors can play safe in market correction by focusing on dividend stocks

An investor can never control market movement, as this is a function of numerous variables. But an investor can certainly control his/her response to market movements. The sad part is, mostly, this reaction turns out to be the opposite of what it should be.

When the market is marching northward, the toughest thing for an investor is to think of selling a rising stock. Then ‘hope’ becomes an overriding factor. It is hard to fight the feeling that the stock is going to fetch more money.

Exactly the opposite happens when the indices start falling, pretty much the way it is happening these days. ‘Fear’ dominates one’s mind then. Even the thought of buying a stock is banished out of  the mind.

In both scenarios, what decides one’s decision is the wild swings in market direction, instead of factors like earnings and discounting.

A caveat, this is not to say that the current phase of correction may not continue. Given the high stock valuations and the countless headwinds faced by the market, both domestic and global, chances are that stocks may stay under pressure.

That said, what one cannot ascertain, especially when panic is all around, is whether the market has formed the bottom or not. This is known only by hindsight.

In such a predicament, there is no need for an investor to go on a holiday. Stock opportunities can be found even in the worst of times.

For this, the first step is to avoid common mistakes made during times of volatility with a bearish bias. The most common, and probably the worst, mistake made is to compare the recent high price of a stock with the current beaten down price and jump to conclusions that since the stock has corrected, it has become a good buy.

To illustrate, if a stock that hit a high of Rs 200 is now quoting at Rs 100, it would appear a good bargain to one. But it could also be that despite falling by 50 per cent, the scrip might still be trading with a gain of 100 per cent from the level it had started moving up a year back or so. But the high hit by the stock creates an anchor in the brain, and most investors go by that. Actually whether a stock is good or bad is decided by the fundamental value of that business and not by the stock price.

One easy way to move in a troubled market is to go by the basics, that is, dividend. If a stock gives a decent enough dividend, it can be bought even if there is blood on the Street. Dividend yield is dividend expressed as a percentage of the current stock price, by simply dividing the annual dividend by the current market price of the stock. If the stock price is Rs 500 and the dividend for the year is Rs 10, then the dividend yield is 2 per cent.

But certain points have to be kept in mind before buying by dividend yield. First, the company should have a track record of giving good dividends for at least seven to eight out of the last ten years. This would mean that the company paid a dividend even when the business was in a down cycle. Many companies tend to be charitable with dividends when the time is good, but turn stingy when headwinds appear. But for an equity investor, what matters is a consistent income as dividend payout.

Second, the dividend yield calculation should exclude special dividends. Many companies pay special dividend to mark special occasions or just to celebrate windfall gains. The dividend has to be ordinary, not special.

Third, a good dividend yield has to be tested against prevailing interest rates. Today, since the risk-free return, as measured by returns on government debt paper, has increased, the dividend yield should also rise in tandem. Taking the interest rate at 8 per cent, a dividend yield of 4 to 5 per cent should be seen as a good buying opportunity for an investor. The difference of 3 to 4 per cent return is what an investor sacrifices in expectation of capital appreciation, which is not available to a debt paper.

Given that the market is correcting, if not today then tomorrow, dividend yields would come to the comfort zone for an investor. So, investors may keep tabs on the dividend yield than the price levels for picking up stocks. A little homework will help one grab a stock the moment it hits the desired yield level.

It has to be confessed here that such techniques won’t work for stocks like Hindustan Unilever or other high priced stocks, as these seldom drop to price levels that make them attractive in terms of dividend yield. The current opportunities are mostly in the PSU space, as investors now have a large number of public sector undertakings to choose from different sectors, ranging from energy to insurance and defence.

Many mutual fund schemes with a focus on high dividend yields have come up in recent years, which gives a certain cushion to investors against price drops, as these funds would be accumulating such stocks whenever the prices fall.

Remember that these are long-term investments. So, there is no need to rush. Wait for the opportunity. Whenever the market is gripped by panic buy the targeted stocks, if the dividend yield is comfortable. Last Thursday probably was a good opportunity lost.

Investors can also think of joining a systematic investment plan (SIP) on dividend stocks in a corrective phase. Anyway, have a portfolio of stocks with higher dividend yields from different sectors, so that even if things go wrong in one sector, capital gains would come from the others to compensate for that. Happy investing.rajivnagpal@mydigitalfc.com

(Rajiv Nagpal is consulting editor, Financial Chronicle)

Columnist: 
Rajiv Nagpal