Consider quality dividend-yielding stocks

Amid increased market volatility and muted earnings growth, investing in such companies should prove rewarding

The volatility in the stock markets in India for the past few weeks was triggered by a mix of global (yuan devaluation and fall in Chinese markets among others) and local developments (weak monsoon, mixed macro indicators, weak corporate earnings).

Experts believe the volatility might continue in the near-to-medium term. Given the correction in share prices, investors can look at companies that pay high dividends rather than the ones which are expected to grow in a big way. Dividend yield stocks typically do not witness significant upmoves or downfalls, offering some cushion against market volatility. Moreover, these are typically cash-rich companies that pay dividend once or twice every year.

Amar Ambani, head of research, IIFL, says, "Long-term investors can consider some extremely safe large companies paying good dividends. For instance, NMDC's cash is about half of its current market capitalisation. Being a government company, it is highly unlikely the dividend per share will fall from current levels. Its extremely rich reserves is another positive." He also likes power financing companies such as Power Finance Corporation and Rural Electrification Corporation.

However, one should put certain checks in place before choosing investment ideas on the basis of dividend yield.

Investors should look at their prospects and pick stocks having reasonably healthy earnings visibility.

The trend in profits is important, especially to gauge if there is any prolonged slowdown in the same, as it could mean that the company might not be able to pay similar dividends in future. Factors like the industry a company operates in, its growth potential, substitutes that could be potential threats to a company's products/services, etc., need to be considered.

While a low debt/equity ratio (applicable in case of non-finance companies) is crucial, many experts say consistent and healthy operating cash flows are crucial indicator of the company's financial health, as it indicates the real cash a company is generating. For instance, the trend in a company's rising profits might appear attractive, but if it is doing so by pushing inventories at the dealer level (enabling it to book sales and profits) the profit might not be real. Hence, the cash it generates is a crucial indicator.

Among other checks, Jagannadham Thunuguntla, head of fundamental research at Karvy Stock Broking, says, "While investors can consider stocks with high dividend yield, they should check on its debt as well as promoter pledge levels as well."

In the BSE 200 universe of companies, about 30 companies had a dividend yield of three per cent plus in FY15, while another 20 plus companies had a dividend yield of two-three per cent. Typically, public sector companies across sectors have been consistent on this parameter and are among the top dividend yield stocks. Thus, 10 of the top 15 dividend yield companies belong to the public sector. These include NMDC, IFCI, Coal India, Syndicate Bank, National Aluminium, Oil India Limited (OIL) and ONGC.

Oracle Financial Services Software, Cairn India, Karnataka Bank and Vedanta are other companies in this list. Experts, however, advise to tread cautiously with respect to commodity companies, given the pressure on commodity prices in India as well as globally, which could keep profits under pressure.

Oracle Financial tops the list; it paid special dividend in FY15, which boosted its dividend-yield ratio. Going forward, analysts were divided on its prospects; and the company's net profit is likely to grow at 9.5 per cent annually over FY15-17, according to Bloomberg estimates. Analysts expect the company's dividend yield to normalise around three per cent.

Similarly, Strides Arcolab also figures at the top of the list but payment of special dividend in FY15 has pushed up the dividend payout ratio and investors should note that similar dividends are unlikely to be declared going forward. Nevertheless, most analysts are positive on the stock, given high earnings growth visibility. Cairn's business is suffering due to crude oil prices fall. Though it has healthy cash reserves and will continue to generate cash from operations, its merger with Vedanta is a key overhang due to investor fears around utilisation of its cash to ease Vedanta's problems. The company management though had tried to allay these fears by stating that it will use Cairn's cash productively going forward.

Among other companies, prospects of Coal India, Oil India, ONGC, PFC and REC appear strong. ONGC and OIL would gain from minimal subsidy burden, which would boost their net realisations. On the other hand, while public sector banks also figure in the list, they might have to raise significant capital to meet Basel III requirements, which, in turn, will lead to high equity dilution for most of them.

If one looks at stocks where dividend yield is between three and four per cent, there are options to consider during this market correction phase. These include HCL Technologies, HPCL among a few others.