Indexology^® Blog

Dividend yield is an important source of total return from an investment in equities. The other source is capital gains. While capital gains tend to be volatile and depend on the stock price movement in the market, dividend income tends to remain stable and depends on the dividend distribution policy of the company. The dividend policy may depend on the stage of the business life cycle, industry, economy in which the company operates, etc.

How India fares globally in terms of dividend yield?

India is an emerging economy and the growth opportunities are tremendous. The corporate debt market is minuscule in comparison to the government debt. Hence the companies are better off when they retain greater part of their earnings, and utilize it in the net positive value investments which generate returns in excess of the opportunity cost of capital. This is evident from the fact that India has historically been a low dividend yielding country. The difference between the yield of the S&P India BMI and S&P Developed BMI was almost 88bps as on April 30 2015. (See Exhibit 1)

Exhibit 1: Historical Dividend Yield

Source: S&P Dow Jones Indices

Comparison of the dividend yield between large mid cap and small cap companies

Indian large mid cap companies have exhibited more stable dividend yield in comparison to the small cap companies historically. At the time of global recession in 2007-08, the small cap companies had a higher drawdown in comparison to the large mid cap companies which led to higher dividend yield of the small cap companies in that period. The difference between the dividend yield of the S&P India SmallCap and the S&P India LargeMidCap peaked at 95 bps on February 28, 2009. (See Exhibit 2) Since the Indian Lok Sabha elections in May 2014, the S&P India LargeMidCap has delivered higher dividend yield than the S&P India SmallCap. (See Exhibit 2)

Exhibit 2: Historical Dividend Yield

Source: S&P Dow Jones Indices

Difference between the dividend yield of Indian value and growth companies

The growth companies tend to utilize higher percentage of their earnings and hence distribute lesser dividends to the shareholders in comparison to the value companies. Therefore the value companies should have higher dividend yields in comparison to the growth companies. The S&P India BMI Value has had higher dividend yield in comparison to the S&P India BMI Growth historically and the difference between the dividend yields of the indices was almost 34 bps as on April 30, 2015. (See Exhibit 3)

Exhibit 3: Historical Dividend Yield

Source: S&P Dow Jones Indices

The dividend yield of cyclical and defensive sectors

The sectors such as the consumer discretionary, energy, financials, industrials, information technology and materials are considered cyclical sectors. Amongst all these sectors, S&P India BMI Industrials had the lowest and S&P India BMI Energy had the highest dividend yield as on April 30, 2015. (See Exhibit 5)

Exhibit 4: Historical Dividend Yield

Source: S&P Dow Jones Indices

The sectors such as consumer staples, healthcare, telecommunication services and utilities are considered defensive sectors. Amongst these sectors, the dividend yield of the S&P India BMI Health Care and the S&P India BMI Telecommunication Services have remained the lowest historically. (See Exhibit 4)

Exhibit 5: Historical Dividend Yield

Source: S&P Dow Jones Indices

The dividend strategy in investments

Many investors consider dividend as important factor in the investment decisions. The models which utilize the dividends to value the companies are best suited for the investors who are minority shareholders and do not possess the power to alter the dividend policy of the company and the company has a stable and sustainable dividend payout ratio. S&P Dow Jones Indices has a vast family of indices focused on dividends like the dividend aristocrats, dividend opportunities, etc. Globally many ETF’s exist which are focused on dividend strategies. Since December 2014, Indian market also has introduced ETF’s focused on dividends.

The week of Sept. 21, 2015, saw a flurry of stories about the escalating cost of drugs in the U.S. marketplace. These stories were all initiated by Turing Pharmaceuticals buyout of the drug Daraprim (NY Times Story) and the decision to increase the price per tablet from USD 13.50 to USD 750.00. Turing’s stated reason for the price increase was the fact that the drug is only distributed to about 2,000 users nationally, and therefore at USD 13.50 the drug was not profitable. However, Daraprim is a generic drug that has been on the market for over 70 years, and therefore it is open to competition. In all likelihood, had the price increase held, Turing would have opened itself up to new competition, which would have forced the price back to a more competitive level. In reality, because Turing is currently the only manufacturer, this situation is similar to when a brand drug is coming off patent, and is still able to attract a premium price, before other competitors have time to introduce competing generics and normalize the market.

As can be demonstrated by the S&P Healthcare Claims Indices, there are volatile escalations in the overall cost of generic drugs from time to time. These swings are often the result of drugs coming off patent and the resulting market opening for competition. Under the U.S. patent law, drugs coming off patent are open to competition by a single generic producer for a period of six months, and that producer would obviously have a huge price advantage over the market for that period of time. After the initial six month period, the market is open to all generic drug producers to compete. During this phase, we would expect to see costs decrease, as fair market competition brings prices to a market competitive level.

Compared with the overall cost of brand-name drugs, the unit cost of generics is still increasing at a much slower pace. We have seen a significant increase in brand-name drugs recently due to the escalating costs of specialty drugs, such as Sovaldi. With all of that said, in the case of Turing’s drug, a target market of only 2,000 users may not attract huge interest by other manufactures to create a product to compete with, therefore it is possible that a generic drug such as Daraprim could sustain a significantly higher unit cost price than a product with a much wider distribution network. This scenario is based on the facts of competitive markets, and it does not take into account the public reaction that drug manufacturers must also deal with on a daily basis. Anytime a drug manufacturer increases the price of a drug that has a critical role in combating a serious disease by over 5,000%, there is likely to be a public pushback, followed by a political reaction, which may be more severe than the drug manufacturer anticipated.

The Bank of Canada left its key interest rate unchanged at 0.5% last Wednesday, Sept. 9, 2015.  The message from the central bank was that it could be “considerable time” before there is significant recovery from the collapse of oil prices that pushed the economy into a technical recession.  The last rate cut was back on July 15, 2015, and the central bank feels the effects of that action are still working their way into the economy.  The number of jobs is also an important factor to watch.  The Canadian economy added 12,000 jobs in August and exports were up for the second month in a row, but the unemployment rate also rose to its current level of 7%.

So far, September has been positive for Canadian indices, as Exhibit 1 indicates.  Bonds rated CCC and lower have returned 0.17% for the month, while they have lost 14.19% YTD, as of Sept. 15, 2015.  The S&P Canada CCC & Lower High Yield Corporate Bond Index was as low as -18.36% YTD as of Aug. 20, 2015, before recovering to the level seen as of Sept. 14, 2015.  The S&P Canada B High Yield Corporate Bond Index, which measures single B bonds, had a total return as high as 5.84% YTD at the beginning of July, but as of Sept. 14, 2015, it has returned 3.29% YTD after bouncing back from a 1.71% YTD return on Aug. 25, 2015.

Exhibit 1: Canadian Indices Returns

Source: S&P Dow Jones Indices LLC.  Data from Sept. 14, 2015.  Past performance is no guarantee of future results.  Table is provided for illustrative purposes.

Little new data, lots of chatter from Wall Street and no clear signals about what the Fed might do at next week’s FOMC meeting. The announcement, either no change or a rate increase, is expected on Thursday afternoon September 17^th around 2 PM Washington DC time.

Those looking for some hint of what this might mean for the stock market can lean on a bit of history reported in the Economist this week.  Since 1955 there have been 12 Fed tightening cycles, averaging two years each with an average increase of five percentage points. Typically recessions appears after three years, but not always. Given the changes in the economy, business cycles and inflation, 12 cycles are not enough observations to identify a pattern.  One favorable piece of history is that in nine of the 12 cycles equity prices rose in the year after the start of a tightening cycle. One reason may be that the Fed tends to move when the economy is strong, earnings are climbing and it fears over-heating.  Today earnings per share on the S&P 500 are roughly flat: the change from June 2014 to June 2015, based on available data, was -3.2%.

For those who prefer pictures to numbers, the chart shows the S&P 500 and the Fed Funds rate monthly since 1954 with recessions marked by the vertical lines. More often than not, rising rates lead to falling stock prices.

The story for bonds is simpler. From the early 1950s to 1982 bond yields rose and bond prices fell.  Yields peaked in mid-teens for treasuries. Since the August 1982 peak yields have come down to their present rock-bottom level. While bond yields may not rise in lock-step with the Fed funds rate, we are at the zero lower bound and the next move will be up. The chart below shows the modern history of US treasury bonds and the Fed funds rate.

Those who prefer trading signals to economic history can look to the CME Group’s FedWatch which offers a probability distribution for the funds rate based on the Fed Funds futures market. As of Friday afternoon, the odds for the funds rate on September 17^th were 77% for 25 bp and 23% for 50 bp.  Looking ahead to the December FOMC meeting, the odds for 25 bp are 41%, 43% for 50 bp and 16% for 75 or 100 bp.

Taking everything together, a rate hike is coming but no one knows when.

In the Islamic Finance News Report “China- the time is now”, it highlighted a few initiatives that demonstrated the rising momentum of Islamic finance in China, see examples below,

• Chinese brokerage Southwest Securities forged a partnership with Qatar International Islamic Bank to pave the way for Islamic finance transactions in the country. The Qatari bank confirmed with IFN that it will leverage on this MoU to develop an Islamic finance framework for China.

• Chinese banking giant, the Industrial and Commercial Bank of China (ICBC), also the world’s largest bank by assets, through its leasing arm entered into a collaborative agreement with the Islamic Corporation for the Development of the Private Sector (ICD), which is targeted to focus on multiple lines to develop Islamic capabilities and opportunities.

Separately, there is news that HNA Group, owner of Hainan Airlines, is planning on issuing USD sukuk.  It would be the first Islamic financing deal by a mainland Chinese company. Chinese property company, Country Garden Holdings, also plans a sukuk programme of at least RM1 billion. Since sukuk is a viable option in a diversified funding approach, more Chinese companies could be expected to tap into the sukuk market.

As of Sep. 10, 2015, the YTD total return of the Dow Jones Sukuk Index is 1.39%.  Among the rating-based subindices, the Dow Jones Sukuk A Rated Total Return Index has outperformed and gained 1.43% YTD as of the same date.

In terms of new issuance, a total par amount of USD 9.5 billion sukuk was added to the index YTD. Sukuk from United Arab Emirates and Malaysia both contributed USD2.75 billion.  Hong Kong issued another USD 1 billion five-year sukuk in June, which reaffirmed Hong Kong’s ongoing commitment to developing Islamic finance in the region.  Currently, sukuk from the GCC represent 53% of the overall market exposure (see Exhibit 1).  Interesting to note, the new issues in the index were all launched in the second quarter, while recent primary activities have been muted on the back of market uncertainty.

Exhibit 1: Market Exposure by Par Amount of the Dow Jones Sukuk Index