The Hindu Business Line : Dividend yields and value managers

THE recent theme in investment management is dividend yield. Most newspaper articles compare high dividend yielding stocks with bank fixed deposits. Beware. Investing in stocks for just the dividend yield is risky. Why?

Dividend yield refers to the returns that you receive in the form of dividends by investing in a stock.

Thus, if you buy a stock for Rs 100, and receive Rs 5 per share as dividends, the dividend yield is 5 per cent (Rs 5/100).

Comparing historical dividend yields with bank fixed deposits is not quite correct because of the difference in the investment risks. If you invest in a bank fixed deposit, you will receive interest, whereas investing in high-dividend yield stocks does not assure you of dividends.

Besides, you are certain of receiving your principal on maturity in the case of a bank fixed deposit. That is not the case with stocks.

What if the stock price declines after you buy it? For instance, if the stock price declines from Rs 100 to Rs 75, you would have lost more due to decline in stock value than you would have gained from dividends.

Therefore, buying stocks just for their dividends may not be a wise investment decision. But some portfolio managers do buy high-dividend yield stocks. Why? These fund managers basically use dividend yields as a tool to pick stocks, not to just receive dividends. Such managers are said to follow value-based investment style.

Typically, stocks provide high dividend yields because their market price is low. Note that their prices are low for some reason.

The portfolio manager's skill, therefore, lies in picking under-valued stocks, adjusted for the risk, from the list of high-dividend yield stocks. They are, hence, termed value managers. And such stock picking is different from investing in high-dividend yielding stocks for just the dividends.

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