How to generate income in a ZIRP world: Dr. Vikas Gupta

With RBI Governor Shaktikanta Das’s MPC statement on April 07, 2021 and Fed Chariman Jerome Powell’s reiteration at an IMF-World Bank economic forum on April 08, 2021, the view that the low/zero interest rate policy is likely to continue in the near future is reinforced.

Both, India’s RBI and US’s Fed are focused on growth and would focus on keeping interest rates low until growth takes a stable trajectory.

Under these conditions, what we call a ZIRP (Zero Interest Rate Policy) World, the problem for income-www.newsbarons.comoriented investors is how to generate adequate income. In this growth-focused, low-interest rate world, dividend-paying stocks are likely to provide a higher total return. However, the dividend yield of Sensex is less than 1%. The typical Indian large-cap company is not going to be provide a high dividend income.

Aren’t there companies which provide higher dividend yields? But what about their safety? What about growth? We addressed this problem by applying our Scientific Investing Framework.

In the growth-focused, low-interest rate world, dividend-paying stocks are likely to provide a higher total return. However, the dividend yield of Sensex is less than 1%. The typical Indian large-cap company is not going to be provide a high dividend income - Dr. Vikas Gupta.

OmniScience Capital’s Scientific Investing Framework is based on the OmniInsight that:

“Most market participants chase alpha but get risks, while one could chase safety and get alpha”

The Scientific Investing Framework is applied to the investment universe and helps in reducing the risks by systematically eliminating Capital Destroyers, Capital Eroders, and Capital Imploders.

Capital Destroyers are companies with weak business operations and high debt on their balance sheets. Such companies have high likelihood of going bankrupt. Investing in such companies is likely to result in the shareholder capital getting destroyed.

Capital Eroders are companies which erode shareholder equity by generating low returns on equity. Even though, these companies generate profits and pay taxes, their profitability is low and not enough to compensate for the cost of capital. Investing in such companies is likely to result in the shareholder capital getting eroded slowly over a number of years—a virtual bleeding to death.

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Capital Imploders are companies which have strong business fundamentals, however, Mr. Market is so excited about these companies that they are priced to perfection. They market price of such companies, typically, incorporates extremely optimistic growth assumptions with very large cash flows for very long periods of time. If during any particular period the company is not able to deliver the expected growth, earnings or cash flows which are priced in, there is a likelihood of a share price implosion. This could lead to a strong hit to the investor’s portfolio. These popular and overvalued companies are also eliminated.

What one is left with is Capital Multipliers. These are companies with stable business operations, strong balance sheets, persistent competitive advantages resulting in high return on equity, and are available near their intrinsic value or significant discount to intrinsic value.

Since the objective is to look for high income generation, we select a group of companies from this which have high dividend yields and are available at significant discount to their intrinsic values. These SuperNormal Companies with SuperNormal Yields have been identified and a portfolio of such companies has been created called Omni Super Dividend.

The Omni Super Dividend Portfolio has 8 companies with a combined yield of 8.26% according to the current factsheet on omniscience.smallcase.com

The most important point about these companies is that the bonds of these companies have been rated AAA by the top rating agencies. This has been discussed in the OmniScience Capital’s Research report titled, “Dividends are Divine in a ZIRP World-Generating Higher Income with Investment Grade Equity – AAA rated companies”.

Most of the companies are dependent on the power sector. But within the power sector these companies are from different sub-industries, i.e. mining, thermal power, hydro power, power trading, power finance and there is also a housing finance company.

This portfolio provides high dividend yields which are likely to quite stable given the policy of their owners. Their owner is the Government of India and their dividend and investment policies are guided by Department of Investment and Public Asset Management-DIPAM.

DIPAM has clearly laid out guidelines for these companies to pay out:

In supersession of earlier guidelines, every CPSE would pay a minimum annual dividend of 30% of PAT or 5% of the net-worth, whichever is higher subject to the maximum dividend permitted under the extant legal provision.

Further, DIPAM states that the companies should strive to pay higher dividends than recommended above, if possible, and pay them consistently throughout the year.

This provides stability and consistency to the dividend pay outs if one is invested in a portfolio of such companies. These companies have strong growth possibilities which will be discussed in future articles.

Mr. Market always makes mistakes in some section of the market. At this time, this not only provides an investor a chance to enjoy a strong income flow of around 8% in a ZIRP World, but also a significant chance of portfolio growth. Of course, the equity risks remain, i.e. the principal and income both are at risk. But as discussed above the income risk is significantly reduced based on the DIPAM guidelines. Equity risks are significantly less compared to the average stock in the market due to the Scientific Investing Framework.

This is not investment advice and investors should evaluate their financial goals, risk profiles, product suitability and other relevant factors before deciding on any investments.

Disclaimer: Equity investments are subject to market risks. Global investments entail currency and country risks. The above is not a recommendation to buy, sell or hold any of the stocks or sectors mentioned. We and our clients might have exposure to the above-mentioned stocks or sectors. Please consult your investment advisor and assess the suitability of investment products for your circumstances before investing.

[This is an authored article by Dr. Vikas V Gupta, CEO & Chief Investment Strategist at OmniScience Capital. All views, opinions and expressions are personal and limited to the author.]