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.
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.
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.