Are you investing in PSU stocks for high dividend yield? Beware!

view original post

’10 stocks that beat Bank FDs with dividend yield of up to 10%’.

‘How India’s top dividend paying stocks of today could disappoint tomorrow’.

I read both articles and formed my own opinion.

The first said you are getting double the FD rate as cash inflow every year. So it’s a good opportunity.

The second spoke about how yesterday’s dividend stocks may be wealth destroyers today.

The concept ofdividend yield investingcannot be generalised. So let me talk about retail investors’ mindset instead towards these stocks.

A few weeks ago a friend called me and asked if he could invest inRECas it offered a whopping 10%+ dividend yield.

His logic was also the same as the first article. He believed if something gives him 10% pa as cash flow, then why does he need tax inefficient FDs. After all, FDs are taxed at 20%. Dividends are taxed at 10% above 1 m.

How I wish investing and making money was so easy.

But it never is.

So should youinvest in dividend yield stocks?

The answer is both Yes and No.

Here are 5PSU stockswhich give the highest dividend.

View Full Image

5 PSU stockswhich give the highest dividend.

The dividend yield column above is indeed fascinating.High dividend yieldin excess of 6% beats FD returns. Also if you look at the valuations, all these stocks are dirt cheap.

I mean stocks like REC andPower Finance Corporationare available atP/E ratioof 2 or 3!

If I was presented this standalone data, I would definitely be a buyer. It’s a no brainer.

But before you form a judgement, do look at the stock price performance over the past 5 years. I’ve excluded 2020 due to Covid.

View Full Image

PSU stocks.

View Full Image

PSU stocks.

The Dividend Myth

From the table above, we see that if you invested in Coal India in 2017, 2018, or even 2019, you would have been sitting on a loss of at least 15-20%. I’m not even considering compounding.

The same is the case for rest of the PSU stocks.

While a dividend yield of 10% sounds very attractive and retail investors get swayed towards it, the bigger point is loss of capital.

Are these reallyfundamentally strong stocks? In all these stocks, even if you assume a consistent dividend yield of 8-9%, a 15-20% loss of capital would erode 8-10% of your capital.

You are better off just investing in aNifty ETF.

Lot of people also tell me, at alow P/E ratioof 2-3, there is no downside.

I partially agree, but if you look at the 5 year median P/E, these stocks have always traded at these valuations.

Unless there is a major change in the way these companies operate or if you are buying these stocks at the bottom of their earnings cycle, there is no way to get decent capital appreciation.

If you would have invested in Coal India at say 100-110, which was the bottom, then your money would have doubled.

But that was at an earnings bottom when there was a coal shortage and a temporary demand-supply mismatch all over the world. It’s more of a trading bet rather than investment.

Coal India gave consistent negative returns over the past 3, 4, 5, and 7 years. Even after doubling from its 2020 lows. It’s still below its price 3 years ago.

What should investors do?

The whole point of investing is to put money in companies which have strong management growth prospects and are available at reasonable valuations.

While PSUs have always had cheap valuations, there is a reason behind it. Unless you can take a call on those things changing for the better, why invest in them?

Also a lot of PSUs are cyclical stocks. Stocks like NMDC is more of a trading bet and not an investment. This is due to fluctuations and volatility in its earnings and stock price.

It’s also wrong to paint all PSUs with the same brush. Some PSUs likedefence stockshave strong runway ahead of us. However these stocks offer capital appreciation and do not providehigh dividend yields.

The focus should be on buying good quality stocks which have decent dividend yield.

My bet would be a combination of MNC stocks and non PSU stocks which offer decent growth. Some of these stocks are available below their long term average valuation and also offer dividend yields of 2-3%.

These stocks would be good picks.

Disclaimer:This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

(This article is syndicated from Equitymaster.com)

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.

More Less

Subscribe to Mint Newsletters

* Enter a valid email

* Thank you for subscribing to our newsletter.