Monday, March 16, 2009

>Dividend Yield Picks (HDFC Securities)

In a volatile market such as now, should one invest in a stock for the dividend it pays? Conventional wisdom suggests one should. In a market downtrend, buying stocks of companies with a high dividend yield is considered a good defensive strategy. Dividend yield, which is dividend per share as a percentage of the market price, is a “value” measure that allows one to buy stocks that are only temporarily out of favor, or perhaps under-priced. Generally, the dividend yield strategy outperforms when the market recovers from the bottom.

In sudden sharp corrections, one may be able to pick up a stock that has a high dividend yield and gain once the market recovers. But timing the bottom of a correction is not easy. And in the interim the share price may fall further causing temporary capital erosion. Thus, such stocks may call for an active profit-booking strategy.

This brings us to the theory of ‘The Dogs of the Dow’ which is an investment strategy popularized by Michael O’Higgins in 1991. It proposes that an investor annually select for investment the ten Dow Jones Industrial Average stocks whose dividend is the highest fraction of their price.

Proponent of the Dogs of the Dow strategy argue that blue chip companies do not alter their dividend to reflect trading conditions and, therefore, the dividend is a measure of the average worth of the company; the stock price, in contrast, fluctuates through the business cycle. This should mean that companies with a high yield, with high dividend relative to price, are near the bottom of their business cycle and are likely to see their stock price increase faster than low yield companies.

Under this model, an investor annually reinvesting in high-yield companies should out-perform the overall market. The logic behind this is that a high dividend yield suggests both that the stock is oversold and that management believes in its company’s prospects and is willing to back that up by paying out a relatively high dividend. Investors are thereby hoping to benefit from both above average stock price gains as well as a relatively high dividend.

To see full report: Dividend Picks