As always there is no simple answer and it depends on many factors. For me, it does not matter whether it is high yield or low yield. One of the key aspect that I look for in dividends is its sustainability.
Focusing on high initial dividend yield may be good for someone who wants to harvest only dividends and get out of the stock. This is a high risk preposition. The dividend cash you receive may or may not cover the stocks price fluctuations. Since I look for longer term, high yield is acceptable, if I am able to understand how the company is sustaining it. Let us take few examples.
CIPLA (my analysis): I looked at this stock in early April 2009. This stock was paying dividend yield of 5.9% in 2002 (and payout factor was in 60% to 70%). It has now dropped to less than 2% (with payout factor in 20s%).
- Although the company paid high dividend in 2002, its cash flow from operations was still less than its net profit. Now, how can one generate less cash and still make profit?
- As you can see in my analysis, it started taking in more debt. Majority of its earnings went into servicing the debt. Similarly, its debt has now increased beyond its ability to generate cash.
- A stock like CIPLA will not be able to sustain its high dividend. And it did reduce its dividend.
- Recently, there was another news article which has expressed similar concerns with CIPLA earnings.
Foseco India (my analysis): Here, it seems the dividend yield is high and hence it is likely the company is good dividend company. Unfortunately, it is not the case.
- My analysis shows that in last three years, its cash flow from operations is less than net profit. Its payout factor is trending upward and is now more than 60%.
- Furthermore, the majority holders have 80%+ stake in the company and hence, most of the dividends are paid to themselves.
- I find it hard to figure out, how the company will sustain its dividends.
Royal Orchid (my analysis): Here also, there seems to be a similar scenario where high dividends are most likely not sustainable.
- For the last three years, the cash flow from operations is consistently less than net profits. Now if there is no cash flow from business operations, where are profits coming from?
- Furthermore, Indian economy boomed from 2005 to 2008. However, Orchids earning per share did not grow (although revenue is growing). Intriguing!
- The promoters have 69.43% holdings (of which approx. 1% increase came in Jan/March 2009). Its dividend payout is factor is 50% or more. Most of yearly earnings per share is going back to promoters in the form of dividends. It appears that the raising of equity allowed it to increase its asset base, revenue, and earnings. I could not understand how will the company grow? I could not understand how my dividends will grow.
Above three stocks are few examples to demonstrate that high dividend yield is not necessarily a good thing. The key is to understand how the company can sustain it. The quality of the dividends and stocks earnings should be good. That will give you long term sustainability and higher total returns.
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