Once one of my clients mentioned that he wanted to prepare an equity portfolio for his retirement needs that should consist of large cap stocks as those stocks offer better dividend yield. During our telephonic conversation, I failed to convince him that even mid cap and small cap stocks can also offer better dividend yield. I know it is hard to believe, so let’s check few real life examples-
During December-2012, I had recommended a small cap Pharma stock named Ajanta Pharma at Rs-250. The stock was not in the radar of mutual fund managers and was quite unknown at that time. Backed by strong fundamentals and better future prospects, the stock generated more than 6 times (550%) return within the next 2 years (CMP -1745). Apart from huge capital appreciation, let’s have a look on the dividend yield part. During July-2014, the company declared 200% dividend on the face value of Rs-5. Thus, it translates into dividend of Rs-10 per share. Now anyone invested during December-2012 would have received Rs-10 dividend on their investment of Rs-250. Dividend yield of 4% is not bad while considering 4% annual interest on savings bank account. So, you have 550% capital appreciation and 4% dividend yield from your investment within 2 years. I can bet, any large cap stock can’t meet this combination of 550% capital appreciation and 4% dividend yield within 2 years.
You may think that Ajanta Pharma is an exception, so let’s have a look on few more stocks. Avanti Feeds, a small cap unknown company from aquaculture sector was trading around Rs-130-200 during June- September last year (in 2013). At the time of writing this article, the stock is trading around Rs-1400 and has offered a dividend of Rs-15 per share. If you had invested in Avanti Feeds at Rs-200, then you would have gained 7.5% dividend yield (on your purchase rate) and a whopping 7 times capital appreciation within just 1 year – impossible for any large cap stocks. Similarly, investment in Page Industries (small cap stock from apparel sector) during July-August, 2012 generated 20% dividend yield and 100% capital appreciation within next 2 years – again impossible for any large cap stocks. Moreover, Page Industries has a track record of offering dividend 4 times in a year! The list has many more in it. There are at least 30-40 small cap and mid cap stocks that can consistently outperform any large cap stocks in the form of dividend yield and capital appreciation. So, who told you that only large cap stocks offer steady cash flow in the form of dividend?
The problem is that while calculating dividend yield, we consider the current market rate. Theoretically, it is absolutely fine to compare dividend per share with current stock price to calculate dividend yield, but from an investor’s perspective isn’t it logical to compare dividend with his purchase rate? It makes more sense. Suppose, few years back, you had invested in a stock at Rs-200. Today, the stock price is at Rs-100 and the company is offering dividend of Rs-4 per share. So, apparently it looks that as per current market rate of Rs-100, they are offering 4% dividend yield, but what about your original purchase rate. You had purchased it at Rs-200 and getting Rs-4 dividend, so doesn’t it makes a 2% dividend yield for you? Statistically, 4% dividend yield is all right but from investor’s point of view it is not. This is another reason for the wide-spread misconception – “Large cap stocks always offer better dividend yield than small caps.”
From the above discussion, now it is clear that if you can select quality stocks from mid cap and small cap space then it can easily outperform large cap stocks on every front – be it capital appreciation or dividend yield or steady cash flow. Moreover, quality small caps can be less volatile than the large cap stocks. During market crash or economic slowdown, large cap stocks may fall more than the “quality small caps”. The only thing that you need to keep in your mind is “quality small caps”. Not all small caps and mid caps will yield the same result. If you arbitrarily select any small cap then the maximum probability is to get negative return. From the entire universe of small cap stocks, only 1%-2% may have all the characteristics of “quality small caps”. So, the story is all about stock selection.
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