A Dividend Bargain

Dividends are usually a signaling mechanism to the markets that the profits are sustainable, the management is interested in creating shareholder value and sharing profits among many others.

In this respect, I’d like to introduce a stock which is a dividend bargain.

How do I define a dividend bargain? A stock whose share price is less than the sum of all future dividends (perpetuity) is a dividend bargain.

Of course, the questions would be – how do I know whether the dividends will be sustainable? And what would be the percentage of dividend payouts? To answer the former question – we need to look at the business, whether it can be valued as a going concern, whether it has a strong parent among other things. To answer the latter, we need to look at past history and see what was the payout percentage that the management declared.

To give an example, here’s one of my favorite stocks, a AAA rated stock with almost 8% dividend yield which has been declaring dividends since a long time. As observed on the chart, the price doesn’t move by much, but dividend comes in like clockwork. Its a boring business though. Ultramarine and Pigments.

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The average dividend payout is 150% per year. On this Rs. 2/- FV share, the dividend would work out to Rs. 3/-. (A stock to remember when interest rates go low and you want to park it in a fairly liquid bond at around 8% tax free dividend yield).

If we assume Rs. 3/- would be paid out till perpetuity in this interest rate environment (AAA bond 10%; post tax 7%), the share price should be Rs. 42.85/- (Rs.3/7%). The CMP is Rs. 39/-. We see that the market values this stock almost fairly.

Now, let’s look at the stock which I think is a dividend bargain. HCL Infosystems. HCL Infosystems is in multiple businesses – system integration and applications consulting (primarily in India), phone and laptop distribution business etc., fairly robust order book in the IT business (to the tune of 4500 cr) and a strong parent in HCL. Let’s look at HCL Infosystem’s dividend history.

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The average dividend payout has been 300% per year since 2004. Even this year, they are already done with 200% dividend, and 100% dividend should be declared in October, going by their history. On a Rs. 2/- FV share, dividend per share would work out to Rs. 6/-.

If we assume this Rs. 6/- will be paid out to perpetuity (one of the strong reasons to assume this is a strong parent; have highlighted the risks below though), the share price works out to be Rs. 86/- (Rs.6/7%).

What is the CMP of HCL Infosystems as of today? Rs. 62/-. That is, the stock is quoting at approx. 30% discount to just the dividend stream of this company.

This stock is not one of those which might compound annually at 20-30% (I don’t know). I however think that there is a one-time 20% upside atleast to the current levels, if the logic of dividend bargain is correct.

Obviously, the market is not foolish, and it has hammered the stock down due to the following reasons (can be taken as risks too) –

a) CBI is probing HCL Infosystems overcharging angle in Commonwealth Games. I don’t know where this will end up.

b) A major part of the business comes through distribution of mobile phones and laptops. And majorly with Nokia on the mobile front. Trading margins in this business are extremely low and with Nokia getting hammered in the outside world, the market has taken a dislike to this stock.

c) Most of their IT business is with the Government. Good luck with getting those due payments cleared quickly (cue: working capital is high).

So there. I think HCL Infosystems is a bargain at current levels (one-time). Thoughts invited. Also, thoughts invited on any other stock in the market being a dividend bargain.

Disc: Initiated a starter position.

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  1. #1 by Prashanth (@Prashanth_Krish) on September 21, 2011 - 10:50 PM

    I have my strong doubts about the logic of buying stocks for dividend. And in times like these, when the market itself is bullish, if any stock has fallen so much so as to be a strong contender for gains through dividend, I suspect it more 🙂

  2. #2 by arjunsgupta on September 22, 2011 - 12:26 AM

    Hi Kiran,

    Have you looked at the restructuring of promoter holdings done in April’11. Initially all the promoter holdings were through HCL Corporation Ltd, which was also the main promoter in HCL Tech Ltd. Now they have two main different promoter companies in HCL Info & HCL Tech.

    Did Ajai Chaudhry have a large stake in HCL Corporation?

    Arjun

  3. #3 by Kiran on September 22, 2011 - 3:03 AM

    @Prashanth – I am not saying its a great stock to own. My argument is only that the market has mispriced it wayy beyond its actual value. I am obviously not buying the stock for dividend – I think the price will appreciate by atleast 20% because it has been beaten out of shape pretty badly, and is looking cheap on this parameter. As stated earlier, I have initiated just a starter position – want to check if my logic is correct.

    @Arjun – I did look at a notice that some group of investors need not be declared as promoters. Not sure of the details of promoter change though. The one item that did interest me was this – http://articles.economictimes.indiatimes.com/2011-07-05/news/29739005_1_warrants-lapse-pledge-shares-promoters – seems like a positive sign. But then again, you can never be sure.

  4. #4 by Prashanth (@Prashanth_Krish) on September 22, 2011 - 1:25 PM

    Sorry Kiran. What I wanted to mean was that if the stock has Fundamental Value at this price point, it may be worth the risk (though technically it is very very weak). But buying for the sake of a dividend payout may not be worth the risk.

    Dividends paid in good times may not get repeated during bad times. Add to it, they are too small a return compared to what other stocks (in same sector if need be) can offer via capital appreciation.

    Money Control says that Redington India is a competitor to HCL-Infsys. Purely based on charts, I would tend to feel that, Redington India will carry a better Risk-Reward ratio than HCL-Infsys.

  5. #5 by Kiran on September 22, 2011 - 3:03 PM

    @Prashanth – The risk is dividends may not get paid perpetually: true. The only reason I made that assumption is that the promoters have a vested interested in the stock, and they have converted quite a significant quantity of warrants into stock at Rs.148/- (ET article linked in the comments). I am yet to read their annual report and the reason for their huge underperformance in Q1…but on this dividend logic basis (as in – not for the dividend payout, but the logic of – if it can pay perpetual dividends worth Rs. 85/-, what about all the other retained earnings and continuing business? There is atleast some residual value you need to attach to all that. The stock price should be definitely more than that).

    As such, people make money on capital appreciation and not dividends – and I mean that in every senses. Rs. 100 stock declares Rs.3 dividend – the stock price falls to Rs. 97/-. People make money only when this Rs. 97/- goes to Rs. 100/- or more (it could have been the case even if dividends are not declared, but then again, promoters have a way of pissing off extra money – so better they pay it out).

    Haven’t looked at Redington India. Will have a look. Thanks for the pointer.

  6. #6 by Dev on September 27, 2011 - 4:47 PM

    Hi Kiran,
    As far as I am concerned, I dont like IT & ITES Stocks much (Just like the great WB 🙂 ). I generally prefer to go for long term growth stories, which have some peculiar past trends (with reference to the concept of boring stock you mentioned, I analysed GAIL and found some very interesting facts – documented at http://essentialassociate.wordpress.com/2011/02/08/how-boredom-made-money-in-stock-market/).
    But the post has initiated me into looking at IT sector for bargains.
    Thanks for bringing up the point

    • #7 by kdaaku on October 1, 2011 - 12:46 PM

      Hi Dev,

      Excellent blog you have out there. Keep up the good work – will keep visiting it.

      Glad to be of some help.

  7. #8 by subbu on October 1, 2011 - 2:21 AM

    Hi kiran
    Nice post. I wanted to know your views about PATNI computer systems. It has a 20% dividend yield and low P/B and P/e ratio.

    • #9 by kdaaku on October 1, 2011 - 12:41 PM

      Hi Subbu,

      Thanks. Well, I am a little negative on the IT industry as such – I see some strucutural deficiencies and am a little wary of investing in them. Having said that, I think I would stick with the top 3 IT firms for now (if at all I want to invest in IT). Patni has got its own set of problems with managing the iGate acquisition – need to give them a a couple of quarters before we take a call on them.

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