Dividends and Buy backs

EXCESS CASH


There are always corporates which work hard to bring in more wealth for their employees and shareholders. However, how is the cash that has been produced be transferred to its real owners - the shareholders? There are a few direct and indirect ways by which this can be achieved. We are going to look at 2 of the ways here.


DIVIDENDS


Dividends are the first and direct way by which excess cash reaches the shareholders. Giving dividends is always a safe way to keep the stock at a higher price. For example, assume that a company AAA gives a generous dividend or Rs.1 per share which is trading at Rs.25. It means, the investor gets 4% money as return via dividends itself. Now, can the stock price fall below to Rs.10 or below? Thought it might be possible, in a general market it wont. Because in this case you are getting 10% money on the investment made which is more than the bank fixed deposits. So, the fact that the company gives dividend itself keeps the stock price higher.

Companies which are in their high growth path do not prefer paying dividends for known obvious reasons. In stead of paying out cash, they can use it more efficiently. Also this is the preferred approach than borrowing money at high interest rate and getting yourself burnt during the hard days.

As a precautionary note, when one selects a stock only on the dividend basis, one should also verify that the company has a long history of giving generous dividends. Moreover, quality of dividend should also be verified. i.e. if a company earns Rs.5 a share and distributes Rs.1 to the shareholders, then even when profits go down by 30% to 40%, the company won't be under pressure in continuing its dividends. But its not the case where the company earns only Rs.2 per share.


BUY BACKS


Though giving higher dividends is very profitable for investors, it has a hidden trap. Investors are taxed twice while getting dividends. Any company that makes profits need to pay taxes to the government. Continuing our previous example, if our company AAA makes Rs.5 a share, it has to pay taxes say Rs.1.50 (or 30%) per share. So the company has only Rs.3.50 as profits after it has paid its taxes. Now if it decides to give Rs.1 per share dividend, there comes the catch. The share holders are taxed on the dividend amount they get (deducted at the source itself). So, in stead of shareholders getting Rs.1 they will get only Rs.0.80 (assuming 20% tax) thus taxing the shareholder the second time. So companies these days are not preferring to pay dividends thus protecting the shareholders from double taxation. In stead they transfer money indirectly by buying back their shares from the market and thereby increasing their ownership in the company. As a result, share prices climb up and if the shareholder has owned the share for above one year, it doesn't come under revenue but under capital gain which is taxed at a lesser rate. The problem with buy back is that it causes your capital to increase and you wont enjoy its benefit till you sell the share to someone else.

Technology stocks

TECHNOLOGY STOCKS AND INVESTOR BEHAVIOR


Today, an investor thinks a myriad times before investing in a business that he understands, however doesn't stop a minute to invest in a technology oriented companies. The buzz of technology and the jargons that linger around the companies traps people easily. Past has shown that investors can show good profits by investing in businesses that are very simple to understand. As Peter Lynch says, one should choose business that even a stupid can understand, because sooner or later some stupid is going to run it.


PROBLEMS WITH TECHNOLOGY STOCKS


The biggest problem with technology is that they get outdated too fast leaving no time for a non-expert to understand, grasp and reach for the change. Technology is evolving faster that ever that you can't imagine what kind of additional features your cell phone you will have 5 years from now, or how thin your laptop would be in a decade. The existence of such devices itself is a question, because one cant rule out the possibility of some advanced device emerging in the market thereby killing the existing ones, just like pager disappeared after the arrival of cell phones. Magnetic tape days are gone, taking with it the companies that manufactured them. The problem with technology is the appearance of one and disappearance of the other is so fast that unless you observe the technology shift at the earliest, your investment might disappear completely.  However, no one can guarantee that the new technology will emerge big. No one yet knows about open-ids. Blue ray disks are not yet popular. These are some examples which support my argument. To put in simple terms, the ice cream parlor near my house is not threatened by some parlor in China, or Brazil. But thinking of a technology company, it is not the case. If someone at the other end of the globe invents the next technology, all the companies that worked on the current technologies are under threat. Being an uninformed investor is very dangerous as your hard earned money can disappear anytime without leaving you much time to save it.



WHAT SHOULD INVESTORS DO?


It is always safe for the investors to keep themselves away from technology stocks if they aren't experts in that area. If he feels that a technology is really promising, here are the things that he can consider -
1. Buy stocks of those companies which manufactures raw materials for the techy companies.
2. List out all the areas which can benefit from the technology (technology consuming companies) and invest in them, rather than investing in the technology producing company.
3. If you are not convinced with the above set of stocks, then look for the companies which has some of its subsidiaries working in that technology, whose value the market hasn't yet recognized. Try treating it as a separate company and give the current market valuations to the subsidiary alone. If it looks very cheap, then buy it.

Hot? Not much

HOT SECTOR

Not only analysts, even common people have started projecting tomorrows hottest sector. Sometimes it comes true, but in other occasions people are punished for having done the same. Is the myth - Tomorrow's sector real? The reason that I get from people are often blunt, the most common being India's growth story. I too believe that India is changing , but only to some extent. As a counter argument, India has been in the so called high growth path even in the past decade. So, going by their argument, India's thirst for power should have been met by now. Rural India in particular are struggling for power even now. At least, there is a 2 hour planned power cut daily in area, and it has been there for more than a year now. Are our power requirements met? If you're from a sophisticated city, you might nod your head. But I wont. Power cut, both planned and unplanned has not gone down for the past 5 years. How should I genuinely believe that in the next 5 years, the whole India's power requirements will be met? The same holds for education sector too. The government is talking about change in syllabus for school children. But, does it suffice? Does it guarantee that a farmer and a tailer can make their children get a college degree? I am really seeing the construction of new bridges throughout Chennai city. I would certainly say that the government is doing something about improving the infrastructure. However I don't really know whether we can reach the place of well grown foreign countries in 10 or 15 years. We might or we might not, I don't know the answer for sure. The so called "tomorrow's sector" has not shown any strength to the public yet. Given this scenario, do we really need to start investigating on tomorrows sector at all?



HOT IS NO MORE HOT

Go a decade back, you will find everyone yelling about IT stocks. Analysts were giving unreasonable valuations to all IT stocks. Now, come back to the present and take this small test.Do this small exercise and check whether I am right or wrong. Write all the company's name in IT industry. If you are not an IT person, I'm sure you might not cross 15 or so. But in India, there are thousands of IT companies now. So, why cant you think of anything more than 15? I will tell you why... A sector becomes hot when most of the companies operating in that sector start yielding high profits and high margins. The high profits automatically attract more competition. Existing companies diversify(diworsefy) in that sector to try out their luck. New companies start emerging. At the same time, people start giving crazy valuations to the sector, particularly during the bull run. Companies with no fundamentals will start issuing IPO's at unrealistic price. And boom... the sector has nothing in it anymore. Due to high competition, margins will reduce automatically. Revenues will come down dragging profits along with them. Analysts will re-rate the companies and throw the sector to dirt. At the end, there will be only few successful companies and a lot of zombies left.



WHAT YOU SHOULD KNOW

People who see sector growth at initial stages get profits if they do a timely exit. Others who believe on analysts lose their money. The same analyst who said that a stock is for long term (may be you can have it forever) will change their opinion in no time. Ask yourself this question - 'Is it worth the struggle?'. Do you really need to look for hot sectors? There are a lot of stocks out there which people are not looking at right now. You can't find a gem in a place were 8 million people (approximately that many people are investing directly or indirectly in Indian stock markets) are doing the same. Go to the deserted places. You may find one.