Like the tortoise in the fable, if slow and steady is your mantra, then flashy stocks that soar and plummet may be too risky a strategy. For investors with a conservative frame of mind, picking up stocks with high dividend yields — immortalised as the Dogs of the Dow — theoretically makes for a safer strategy.

But does it really pay to invest in a basket of top stocks by dividend yield?

Yes, it does, as the numbers show. Back-testing from 2008, picking the top 10 dividend yield (ratio of dividend per share to its price) stocks at the start of each year, and held for that year, would show quite a consistent performance.

The period between 2008 and now is as good as any to run such a test, with down-trends interspersed with upbeat markets.

In this period, the returns of the portfolio of the top 10 companies by dividend yield in the CNX 100 Index have beaten returns of the broad market gauge, the CNX 500 index, in all seven years, except 2013. The returns for both the index and stocks incorporate the dividends paid. With a new year just under way, it is a good time to stock up.

Stability at what price? Only those stocks in the CNX 100 index, which is made up of the largest listed companies, have been considered for two reasons.

One, given that investors seeking dividends are generally risk-averse, going for smaller companies defeats this purpose. And two, bluechip companies are also less likely to alter dividend payouts and are more cash-rich.

Consistent payout of dividends is a sign of stability of profits and thus, companies that declare regular dividends are usually safer.

But to ensure that you are not paying too high a price for that stability, dividends need to be measured against the stock price. Grasim Industries, for instance, paid ₹21 in dividends through 2014. But you would have had to pay around ₹2,600 to buy it in January that year, translating into a dividend yield of 0.78 per cent.

This is why picking stocks with yields higher than the index is a better bet. Going after dividend yield also plays out as a contrarian move, as such stocks are normally not the market’s favourites. In bull markets, it helps by avoiding overheated stocks, driven by sentiment. In bearish markets, the fact that they pay good dividends supports prices.

It’s a dog’s world The dividend strategy involves going after the 10 highest dividend yield stocks at the start of each year, and holding them over the course of the year. The investment capital should be split equally between these stocks.

This exercise is repeated every year since stock price movements change the dividend yields.

Since 2008, investing in ‘Dividend Dogs’ at the start of each year would have paid off in nine times out of 10. The 10-stock portfolio in each year except one averaged returns above the broad market indicator, the CNX 500 index, and better than the bellwether Nifty index and the CNX 100 index, to boot.

For instance, investing in the top 10 dividend yield companies of the CNX 100 index in January 2008 would have seen value dropping 15.7 per cent in that year. This is far better than the 55 per cent drop in the CNX 500 and the 52 per cent fall in the CNX 100.

The presence of Hindustan Unilever, GSK Pharma, Godrej Consumer and Colgate-Palmolive in this group, all of which gained in the year as others fell, helped.

Similarly, in 2012, even as soaring prices of mid-cap stocks lifted overall market returns, the top 10 dividend yield stocks still eked out slightly better returns. The 10-stock portfolio in 2012 gained 37 per cent, including dividends, compared with the 36 per cent of the CNX 500. The CNX 100 index was up 31.4 per cent in 2012.

In 2013 alone, when markets were largely in a sideways movement, did the strategy fail, and quite spectacularly at that.

That year, the portfolio had two big-ticket banking stocks — Punjab National Bank and Union Bank. Banking stocks pretty much imploded that year.

The 10-stock portfolio lost 18 per cent that year even as the CNX 500 gained 5 per cent.

And even if you wanted to spread out risks more and take on a bigger basket of stocks — say, the top 15 instead of the top 10 — the outcome remains the same. For this analysis, the dividend yield as of January in each year was considered to arrive at the portfolio. The returns for each year took into account the dividend paid during the period. Returns have been measured against the CNX 500 index as the index represents the market, accounting for over 90 per cent of the market cap. Beating the market is, of course, the goal for any investment.

Sector fortunes The consumer play supported returns in 2008 and again in 2011, when the overall market headed south. Hero MotoCorp, ITC, Colgate-Palmolive and GSK Consumer Healthcare again delivered returns above the market in 2011. But with the blistering run the FMCG sector has had since then, none feature in the top 10 in later years.

That position was handed over, instead, to banks, financial institutions and oil marketing companies. Four of the top 10 stocks in 2014 were banks. With Union Bank, Canara Bank and Punjab National Bank delivering total returns upwards of 68 per cent, it paid off handsomely.

Steel and cement were two other sectors that cropped up between 2008 and 2010, but didn’t feature thereafter. The year 2009, in fact, had three steel plays in JSW Steel, SAIL and Tata Steel.

HCL Technologies made the list in earlier years but has not surfaced of late. Capital goods stocks Cummins and BHEL also featured regularly.

Bajaj Holdings and Tata Chemicals are two stocks that have been top-yielding stocks in several years.

To get some idea of stocks which have high dividend yields, look at the constituents of the CNX Dividend Opportunities Index. The methodology the index follows is to first take out the largest 300 companies by free-float market capitalisation and then take the top 50 with the highest dividend yield.

Dividends ahoy Rise in stock prices is one thing. But for those seeking dividends, consistency in their payout is a key factor. One-off or special dividends can impact dividend yields significantly for that year.

If dividends are not paid at the same rate in the following year, it can affect total returns. For instance, Hero MotoCorp getting top billing in 2012 and 2013 is mostly attributable to one-off dividends paid.

The company’s dividend payout ratio, or the proportion of dividends paid to net profits, has been haywire in the past seven years.

Union Bank saw dividends paid jump 51 per cent in fiscal 2011, hold steady for the next two years, and then plummet 47 per cent in fiscal 2014.

But for the most part, stocks that have frequently figured at the top in dividend yields, payouts during the fiscals between 2011 and 2014 have been steady.

Payout is, however, lower than in 2010 and 2009, primarily because net profit growth has slowed sharply.

Bajaj Holdings, for instance, has paid out dividends of 15 to 17 per cent of net profits between fiscals 2011 and 2014, but this figure is far below the 23 and 31 per cent of profits it paid in the two preceding fiscals.

Tata Chemicals has kept dividend paid constant since 2011 even as it recorded net losses in fiscal 2014.

NTPC’s dividend payout has improved from 33 per cent in 2011 to 42 per cent now.

The stocks now This year, the factor of consistency in dividend as well as sector prospects should be considered in stock picking. The top 10 stocks by dividend yield now are very heavy on oil and gas which don’t really have bright prospects. Wielding a bit more judgement in choosing dividend yield stocks is, therefore, necessary.

In the trio of BPCL, HPCL and ONGC, only ONGC has seen any sort of consistency in dividend payouts.

Besides the gloomy oil picture, potential disinvestment may weigh on the prices of these stocks in the coming year. Cairn India, currently at the top with a dividend yield of 5.24 per cent, has been paying dividends only in the past two years but has had a bad run in the stock market simultaneously.

Excluding these, the basket of stocks presents a good mix of sectors — banking, steel, power and cement — in effect, sectors that will directly benefit from an improvement in economic growth and pick-up in the investment cycle.

The 10 stocks are NTPC, Power Finance Corporation, SAIL, Tata Steel, Canara Bank, Tata Chemicals, ACC, Bajaj Holdings, Bank of Baroda and Power Grid Corporation. They have more or less consistent payout ratios.

Stocks such as Colgate-Palmolive, IDFC and Ambuja Cements also trade above the CNX 100 dividend yield and have a history of consistent payouts.

Choose the mutual fund route

The trouble with following a strategy of investing in high-dividend yield stocks is that the portfolio needs to be churned each year as yields change. It may also be difficult to zero in on these stocks every year.

And if you happen to sell the stocks before a year is up, you will have to pay short-term capital gains tax.

Taking the mutual fund route can help overcome these issues. Mutual funds that are built along the dividend yield theme invest a majority of their portfolio in stocks which have a yield higher than the Nifty or the CNX 500 index.

This parameter is combined with other metrics, such as price-earnings multiples. While the portfolio is tilted towards safer large-cap stocks, their mandate allows these funds to invest in smaller companies as well, which can boost returns.

Invest here There is not really a wide variety of funds to cherry-pick from. You have a choice of seven dividend yield funds now, of which ICICI Pru Dividend Yield Equity has a track record of less than five years. The average returns of these funds in one, three, and five-year periods are at 53, 23 and 14 per cent, annually. In comparison, overall market indicator CNX 500 index has delivered returns of 40, 21 and 9 per cent, annually.

Of the six funds with lengthier histories, the best of the lot is BNP Paribas Dividend Yield. The fund has markedly picked up performance in the past three years; in the sideways market of 2013, for instance, the fund’s 3 per cent return was far above the category’s 3 per cent average loss. Its one-year 52 per cent return doesn’t match up to the leader Escorts High Yield Equity’s 71 per cent, but the fund has a far better track record over the longer term.

The fund has outdone its benchmark CNX 200 index around 85 per cent of the time on an annual rolling return basis in the past five years.

Tata Dividend Yield is another fund that has similarly scored over the long term. It follows a more conservative investment style, investing in far fewer mid-cap stocks than most peers.

Benchmarked against the CNX 500, the Tata Dividend Yield fund has beaten the index by a margin of 1 to 6 percentage points over one, three and five-year periods.

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