smallcases in focus, April 2024

Why are Dividend smallcases underperforming?

Over the last three years, our dividend smallcases have been underperforming its respective benchmarks. We believe in communicating about our underperformance and hence in this writeup we will walk you through the reasons behind this underperformance. The smallcases in focus are – Dividend Stars, Dividend Aristocrats, Dividend Smart Beta.

Firstly, let’s take a look at the performance of the three smallcases since Sept ‘21 till Apr ‘24. 

As you would know, these dividend smallcases are model smallcases. Therefore, there is no scope for analyst discretion when it comes to selecting stocks or sectors. To refresh your memory, the way model smallcases work is they have a defined set of factors, which gets applied to a broader stock universe and all the stocks that qualify the criteria move to the next stage. Post which, the top 10 or 15 stocks, which exhibit the highest linkage with the model factors get selected into the smallcase. 

Now, let’s start diving deep into each smallcase and get to the bottom of the issue. Let’s begin with Dividend Stars.

How to read this table? 

No. of Companies – From each sector, the number of companies that are/were present in the smallcase between Sept ‘21 to Apr ‘24. For instance, there are/were 5 companies in the smallcase from Information Technology between the mentioned period.

Sector-  The unique list of sectors that are/were present in the smallcase between Sept ‘21 to Apr ‘24. 

Avg returns-  The average returns that the smallcase has generated out of these specific sectors. For example, the Information Technology sector generated an average absolute return of 22.7% between the mentioned period.

So where does the problem lie? 

1. Utilities – Under this sector, we have two companies (Mahanagar Gas and CESC). The underperformance has come from Mahanagar Gas as recent policy changes had witnessed a sharp price correction in gas utility companies. 

2. Materials – Out of the 5 companies in Materials, we have exited 3 stocks in the past and they have been laggards for the smallcase. We had one chemical stock under materials, which didn’t perform for us. We also have had a paper stock and a construction company which didn’t augur well for us, as our entry point was not right.

3. Information Technology – IT sector has been in doldrums since 2022 on the back of budget constraint for companies to expend on IT services. But since these companies have a high dividend paying habit, they got self selected into the smallcase. 

Next up is Dividend Aristocrats.

For this smallcase, Materials and Consumer Discretionary were the culprits behind the underperformance. 

1. Materials – The two companies continue to be a part of the smallcase, however the performance hasn’t come through for either one of them. In general, we have seen companies from this sector struggling with inflation and demand issues. 

2. Consumer Discretionary – La Opala R G is the company under this sector. Again, performance has not been good for the company and we have been hearing from the management about the lethargic demand that is hurting their business. Also, their business is closely tied up with the wedding season and over the last 5 to 6 quarters, we have seen fewer wedding dates due to inauspicious days occurring more.   

Lastly, Dividend Smart Beta. 

This smallcase has been facing issues with the majority of the sectors chosen. 

1. Gas Utilities – We have spoken about gas companies and the issue they have been facing post policy change announcements. 

2. Communication Services – Info Edge is the company under this sector and we continue to hold on to the stock. However, performance has been on the negative side which can be seen from the table as well. The portfolio companies of Info Edge have been under pressure which has been the main reason for its underperformance.

3. Information Technology – None of the IT companies have made money for the smallcase and the reasons are pretty much attributed to the tight budget.

4. Healthcare – This sector has had an extremely volatile ride ever since COVID hit us. Obviously in 2020, everyone wanted to invest in healthcare companies.  Then in 2021, everyone was done with this space and they said that there is no story left for further upside. Again from early half of 2023, the defensive play began to come back and investors started investing in healthcare. Therefore, we have had 2 companies here. One which was entered in 2021 and another which was entered in 2023. The former returned negatively, while the latter is present in the smallcase currently and has performed well. 

Given the nature of the smallcase, the primary aim is to pick companies that either have a consistent dividend paying track record or have consistently increased their dividend payouts. At the end of the day, these things are a function of the market cycle. During a risk-on market cycle, these cash rich companies usually tend to underperform as investors exhibit higher risk taking appetite and are willing to take bets on smaller or turnaround companies.    

_{Disclaimer: Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.}

_{The content in these posts/articles is for informational and educational purposes only and should not be construed as professional financial advice and nor to be construed as an offer to buy /sell or the solicitation of an offer to buy/sell any security or financial products.Users must make their own investment decisions based on their specific investment objective and financial position and using such independent advisors as they believe necessary.}

_{Windmill Capital TeamWindmill Capital Private Limited is a SEBI registered research analyst (Regn. No. INH200007645) based in Bengaluru at No 51 Le Parc Richmonde, Richmond Road, Shanthala Nagar, Bangalore, Karnataka – 560025 creating Thematic & Quantamental curated stock/ETF portfolios. Data analysis is the heart and soul behind our portfolio construction & with 50+ offerings, we have something for everyone. CIN of the company is U74999KA2020PTC132398. For more information and disclosures, visit our disclosures page here.}