Dividend play and how investing in bank stocks and public sector units different from the rest?

While steel plants and the business of jewelry should also be relevant for years and decades to come, there is a difference: banks finance all kinds of businesses from small retailers to large corporates and government projects. In other words by investing in bank stocks, one gets exposure to the growth of the economy as a whole. It is said that banking closely mirrors the economy.

There are many businesses (like a firm producing accounting software) that did not exist a few decades back and one cannot be sure what lies ahead in a few years’ time with a rapidly changing distribution channel/consumer taste/change in technology. For such stocks, it is difficult to spot the right time to exit and passive shareholders who are taught to invest for the long-term often lose a significant part of the portfolio.

Government-owned banks (PSUs) are also a vehicle that keeps the government running by generating income through dividends. Most of these banks in good times declare rich dividends ensuring that you also earn decent yearly income in case you stay invested. As of April 2020, dividend income is taxable in the hands of shareholders (How dividend income is taxed in India now – All you need to know). Dividend stripping is a strategy to be considered by investors as and when a dividend is declared.

You can, of course, spread risk by investing in a number of public and private sector banks as under exceptional circumstance a bank too can go bust as evident in the Global Trust Bank fiasco (2004). This also helps optimize returns from dividends, and a way to optimize the same can be through investing in mutual funds focused on bank stocks like Invesco and UTI Banking. These mutual funds, in addition to bank stocks, may also invest in companies engaged in financial service activities or companies engaged in allied activities related to the banking sector.

Of late, there is a flux of new so-called payment banks that leverage online payment gateway technologies pioneered by the likes of Paytm, and it would be interesting to see how they do in the equity market going forward.

All being said, here is an observation by GAM Investments worth mentioning: Dividend-paying stocks are attractive in a world of near-zero interest on bond investments. However, only picking the highest payers is too simple an approach and may risk ending with a dangerously unbalanced portfolio, in our view. And it might not even deliver what it was supposed to do in the first place. The study warns that dividend yields alone do not work as a primary stock selection tool.

To conclude, a dividend is not a guaranteed income. Even if a company is recording big profits, it may decide to cut dividends because of its decision to invest in the growth of the company rather than distributing the profit to the shareholders.

In the context of public sector units, the government being the biggest shareholder usually declares higher dividends in order to meet its day-to-day costs. In this List of Best Dividend Paying Stocks in India, 7 out of 11 belong to the public sector (except Vedanta, Reliance Industries, Hero MotoCorp, and Infosys). In the process, individuals and fund houses invested in the public sector stocks also earn dividends.

But what if the public sector units start making losses?  Check this story Bank dividend dry up further: Only two of 21 PSU banks pay it by The Economic Times dated June 23, 2018, which reported: Dividend payouts for FY18 would be the worst by Indian state-run banks since FY09 when the economy was seeking to clamber out of the subprime sinkhole. The payouts have fallen progressively since FY15 when banks led by the State Bank of India had paid the government Rs 6,940 crore in dividends.