Portfolio Management |
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Whether you are a small investor or a successful fund manager or a stockbroker, you need a strategy to pick-up the stocks. A company with a solid earnings history and good prospects for the future may be a sound investment candidate. Alternatively, a company may not be consistent in earnings history but may be a lucrative buy if they pay consistent dividends. There is no single approach to make you successful in equity investing but the combination of all the approaches in a balanced way can give you the best returns. Fundamental analysis of stocks is widely used to support the nature of your investment. In general, fundamental analysis not only deals with the numbers and ratios to value a company but also considers management, brand value, competition in the industry and the growth of the future earnings. But the ratios can definitely give you some indication as to which stocks are good at a particular time. For example, price/earnings (P/E) ratio shows how much investors are willing to pay for a rupee of a company's earnings. A P/E of 15 indicates, for every Re.1 of per-share earnings, investors are paying Rs.15. A company's P/E ratio should be measured against those of its competitors. For high-growth stocks, the P/E is often measured against the projected earnings growth rate, so a company with annual earnings growth potential of 30% could warrant a P/E ratio of 30 or more. When its P/E ratio falls below that of the market, its peers, or its growth rate, a stock may be attractive for purchase. There are many more analysis like this. In this issue we bring you three different approaches viz. income investing, growth investing and value investing for selecting stocks for your portfolio. Income investing: A great way to obtain monthly income is to invest in good dividend-paying stocks. Most companies pay dividends on a quarterly basis; hence you need to purchase several different stocks whose dividend payments are staggered. When you are buying a good dividend paying stock, you are not necessarily looking for a stock that will appreciate by double of it’s value in a year's time but you are looking for one that will pay you regular and substantial income and additionally give you adequate protection on the downside. However, simply investing in companies with the highest dividend may not solve your purpose of income investing. More important is the dividend yield, which is calculated by dividing the annual dividends per share by the share price. This represents an annual rate of return a stock would provide on the basis of its dividend alone. A dividend yield higher than the post-tax yields of fixed income securities is definitely a good option for investors who look for income investing. As dividends are paid from the Net Income of the company, it is always better to check the consistency of dividend yields of selected stocks to see whether the company would be able to sustain the same level of yields in foreseeable future. In general, companies with low growth prospects offer a high dividend yield, against those with high growth prospects. Important to mention that dividend yield has an inverse relationship with price. Hence, in a bull market, even if the dividend rate is high, as the share price is relatively higher, we may find the dividend yield lower. Same way in a bear market, when share prices are low, dividend yields tend to move up. |
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| Dividend Yield (%) for Income Investing | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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| Here, we have identified a few
stocks which would help you to plan your income investing depending on the dividend yields
(see the above table). Dividend yield is summed up with capital gain or loss on the stock to calculate “total returns”. An analysis on 'total returns' indicates that only three companies gave positive total returns in last five to six years. The three are Infosys Technologies, Hindustan Lever and Oriental Bank. Growth Investing: Growth investing is selecting and buying stock in companies that tend to grow substantially faster than others. The idea behind is that a grow in earnings and/or revenues would directly correlate into an increase in the stock price. Over the past few years, technology companies have been recognized as growth stocks. Although, this strategy has proven sustainable over a long period of time, growth investing involves special risks and as such, may not be suitable for all investors. The other characteristics of growth stocks include higher than average P/E ratio and poor dividend payout. Because, fast-growing companies need their capital to finance their expansion. And most reinvest a high portion or all of their earnings in their own businesses. One way to find out the stocks for growth investing is to take a look at the Return on Equity (ROE). Philip Fisher in his “Common Stocks and Uncommon Profits”- an investment classic of 1958 has indicated ROE as one of the most desirable factors to identify good stocks. ROE, in general indicates what return a company is generating on the owners' investment. Therefore, for higher growth companies, you should expect a higher ROE and averaging ROE over the past 5-10 years can give you a better idea of the historical growth. Also remember, ROE is comparatively lower in case of capital intensive companies, (eg. Reliance industries) as these companies need to invest regularly to buy machinery or drive a technical upgradation process. Another important factor to keep in mind about ROE of capital intensive companies is, high ROE does not necessarily mean high growth of the company because when machinery are taken on lease instead of buying for business, ROE of the company will shoot up. The classic example is of Reliance Petroleum whose ROE is as high as 59.8% as compared with 22.7% ROE of Reliance Industries for the year 2001. No wonder, the major part of the machinaries for Reliance Petro is taken into lease from Reliance industries in this case. |
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| Back to Case-Study Home | Contd : | " Another way of identifying the growth stocks is to look at P/E ratio." | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
IDEAS: Portfolio Planning |
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