Dividends: There's more to it... - Views on News from Equitymaster

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Dividends: There's more to it...

May 11, 2005

FY05 was another good year for India Inc. as far as the financial performance was concerned. Similarly, it was good time again for investors, as stockmarkets gained further ground during the fiscal with the BSE-Sensex notching gains of over 16%, post the 83% rise witnessed in FY04! Apart from the capital appreciation witnessed by investors of their portfolios, they were also rewarded in another way. This was the continued dole out of strong dividends by corporate India in FY05, which was the icing on the cake being enjoyed by investors. In this article, we try to throw some light on this very aspect of dividend payouts and how should investors understand the same.Most of the industry honchos maintained/increased their dividend payouts during FY05. To consider a couple of these for explanation assistance, while two-wheelers major, Hero Honda, maintained its dividend payout at 1,000% (Rs 20 on face value of Rs 2 per share), others like foods major, Dabur, and aluminium major, Hindalco, increased their dividend payouts. While Dabur hiked its dividend from 200% in FY04 (Rs 2 on face value of Re 1 per share) to 250% (Rs 2.5), Hindalco increased the same from 165% (Rs 16.5 on face value of Rs 10 per share) to 200% (Rs 20 per share). While this is a positive development from the investors' point of view, as it indicates investor friendliness of the company and the managements' intentions of sharing its profits with its shareholders, investors need to look beyond dividend payoffs while investing in stocks on the premise of attractive dividends. This is because there is more to dividends than just the dividend per share (DPS).

A couple of the important financial parameters that need to be considered, before zeroing in on a particular investment candidate (stock) on the basis of DPS, are dividend yield and dividend payout ratio. Apart from these two, there are others that will be discussed in brief below. Let us begin.

Dividend yield: This is the dividend declared by a company in a year divided by the current market price of the company's stock. Thus, in the case of Hero Honda above, at the current market price (CMP) of Rs 550, the dividend yield works out to 3.6%. Similarly, for Dabur and Hindalco, the dividend yield works out to 2% and 1.6% respectively. This is an important factor that an investor should consider, primarily for two reasons. One, when the dividend yield is high i.e. above the return on a fixed or savings deposit, the stock becomes an attractive proposition for investment. High dividend yielding stocks are generally those where growth prospects are very slow and companies distribute a larger share of the profits, as they find no opportunity to invest excess cash. Secondly, if the dividend yield is low, then the stock is not a 'value play' in most cases. Thus, none of the stocks mentioned above are strictly strong dividend (yield) plays.

Dividend payout ratio: This is another important parameter that must be kept in mind. This ratio is basically to gauge how much of the earnings (net profits) are distributed by the company to its shareholders. Thus, in the case of Hero Honda and Dabur above, while their dividend payout ratio works out to about 0.5 each, i.e. almost 50% of the net profit was distributed as dividends; Hindalco distributed only 14% of its net profits as dividends. So, from this point of view, the former two are more investor friendly than the Birla group company.

However, judging a company only on the basis of the above two parameters would not be enough and few more points need to be considered, which are discussed below in brief.

Dividend history: This is basically the dividend-paying trend of the company over the last few years. Thus, needless to say here that those one-off special dividend payoffs by companies need to be stripped off and then the dividend trend needs to be considered. A consistent/increasing dividend history indicates that the company is largely confident of its future growth prospects and prefers to share its profits with shareholders rather than hoard cash in its balance sheet.

Don't forget the fundamentals: Dividend or no dividend, this is the most important aspect for every company and its stock price. This is because, dividends are part of profits and if the profit earning capability of the company is at risk then expecting consistent dividends would be nave.

Further, investors must also remember that labeling a company as investor unfriendly on the basis of dividends would be unfair. This is because, typically, if a company needs consistent cash flows to grow, it would withhold its profits, rather than take on debt from the market, to fund its business expansion activities (Hindalco).

Thus to conclude, while the above checklist may not be exhaustive in nature, keeping a close eye on these would mitigate risks to a great extent. Moreover, considering just one of the factors listed above in isolation and deciding upon an investment candidate would not be the most sensible thing to do.

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