“A good man leaves an inheritance to his children’s children.” ~ Proverbs 13:22a, Bible
What kind of gifts would you consider giving your children and grandchildren when you retire from active work?
In the days of my grandfather, leaving the next generations with cash, gold, and property was a good idea. Of course, this is a good idea even now.
But if you ask me if there’s anything still better than these assets that I’d love to leave for my children and grandchildren*, it would be a portfolio of ‘double compounding’ stocks.
You know the power of compounding, right?
In a bank, your Rs 1,000 deposit, which earns 10% (assume) annually, will turn to Rs 1,100 at the end of year 1, Rs 1,200 at the end of year 2, and so on. This is the concept of simple interest.
In the stock markets, if your stock earns 10% in the first year, your investment at the end of year 1 will be Rs 1,100 (same as what your bank account will give). But at the end of year 2, at the same 10% return, your investment value will be Rs 1,210. This is because, during year 2, your 10% interest will not be on Rs 1,000, but on Rs 1,100.
This is the concept of compound interest, which in simple terms means interest on interest.
While you may say that the extra gain from stocks due to compound interest at the end of year 2 (Rs 1,210) isn’t much as compared to what a bank account can give (Rs 1,200), see here how the power of compounding works over a 25 year period.
Data Source: Safal Niveshak Research
As the above chart shows, Rs 1,000 invested now, and generating a return of 10% per year, will grow to Rs 3,500 at the end of 25 years when you earn simple interest from a bank.
The same Rs 1,000 invested in a stock, and which also returns 10% per year over the next 25 years, will grow to Rs 10,835, or more than 3 times the bank deposit.
That’s the power of compounding.
But what’s the power of ‘double compounding’? Well, you can also call it ‘compound interest on steroids’.
This is when a stock compounds your money every year (like you saw in the above chart), and it also gives you a constant stream of dividends that you can reinvest to again compound your money.
Such stocks are able to generate greater long-term returns than other stocks, or any other similar investment.
So in the above example, if we add a stock that…
- Rises 10% every year for 25 years,
- Pays consistent dividend of, say, Rs 50 per share every year, and
- These dividends are reinvested to earn 10% compound interest every year
…Rs 1,000 invested now would be worth around Rs 15,700 at the end of 25 years, or even higher than the return from a stock that only rises 10% every year and doesn’t pay any dividend.
Data Source: Safal Niveshak Research
Is this for real?
“Are such gains for real?” you may ask. “Such stocks might be really hard to find, right?”
Indeed, it’s hard to find such stocks. But then here is a list of stocks that have been ‘double compounding machines’ in the past, and still pay high dividends.
Data Source: Ace Equity, Safal Niveshak Research; D/E = Debt to equity
* Valuations are calculated using last 4 quarters’ earnings and book value
As you can see from the table above, these stocks have had high dividend yields over the past 10 years, and still sport a high number.
What is more, I have included only those companies in this list that have not taken large debt/borrowings on their books in the past (as seen from their low or nil debt-to-equity ratios), and they don’t have high borrowings even now.
How this filter of low debt-to-equity helps is that it removes companies that might have taken bank loans and other borrowings in the past to pay consistent dividends to shareholders (largely to maintain a good image), which is not a shareholder-friendly policy.
Anyways, if you are confused about the term ‘dividend yield’, it is simply the amount of divided you earn from the stock divided by the price you paid for the stock.
So if you bought a stock for Rs 100, and it pays you Rs 5 per share as dividend, your divided yield is 5%. For such a stock, you are earning a 5% return (or yield) even if the stock price doesn’t move at all.
Should you buy these stocks right away?
Stocks mentioned in the table above are some of the best and most consistent dividend payers in India and that too while having their D/E ratios low (or nil).
But that doesn’t mean you go all out and buy any or all of these stocks after finishing reading this post.
You still need to…
- Understand the business
- See whether the management is capable of taking the company in the right direction
- Gauge other financial aspects of the company, and
- Find out if the stock is available cheap (as seen from its valuations like P/E or P/BV ratios that I’ve included in the table above)
Only then you should take the decision to buy any or all of these stocks.
But then, the analysis I’ve done in this post provides you a great starting point to find out the best stocks among these that you would love to gift to your children and grandchildren (like I’ll be trying to find out at my end*).
* Though I’m too young to talk about gifting stocks to my children and grandchildren, in investing, the earlier I start the greater I can accumulate over the long run (thanks to the power of compounding). This also holds true for you.
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Disclaimer: The author of this post, or any of his family members, does not own any stocks mentioned herein. The opinions in this post are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies is not an indicator of the future. The information in this post is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.