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Dividends: Two sides of the story - Views on News from Equitymaster
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  • Sep 12, 2003

    Dividends: Two sides of the story

    In the recent bull run on the stock markets almost all attention is concentrated on the capital appreciation front. However this is not to say that investors are oblivious to the dividend making opportunity as far as the stock markets are concerned. However, before we begin this article, let us first look at the changes announced pertaining to dividends (regarding stocks) in the last two budgets.

    • Budget 2002-03: Distribution tax of 10% on companies and mutual funds on the dividends or income distributed by them abolished. Such income will henceforth be taxed in the hands of the recipients at the rates applicable to them, and will be subject to tax deduction at source at 10%.

    • Budget 2003-04: From April 1, 2003, dividends tax-free in the hands of the shareholders. However, there will be a 12.5% dividend distribution tax on domestic companies.

    Company Dividend Payout FY02 (%) Dividend Payout FY03 (%) PAT growth FY03 (%)
    HLL 35.7 70.5 11%
    SBI 13.0 14.4 29%
    HPCL 43.1 44.1 95%
    ITC 27.8 27.1 15%
    Ranbaxy 46.0 44.6 147%
    Reliance 17.7 17.0 45%
    Dr.Reddy's 12.5 9.8 -15%
    HDFC 52.5 38.9 19%
    Tata steel 35.4 23.7 198%

    Note: Profit growth includes the effect of extraordinary items

    As can be seen from the table above, despite the companies (under consideration) registering higher growth in profits in FY03 (barring Dr. Reddy's), the dividend payout ratio has actually reduced when compared YoY for most of the companies above. While HLL has doubled its dividend payout, Tisco has reduced its dividend payout significantly. Now, here we are not saying that the management of HLL is better than that of Tisco, though dividend payouts do signify (to a certain extent) the management's intention of sharing the wealth created with its shareholders.

    However, while there can be arguments on both the fronts i.e. dividend paying and non-dividend paying companies, it has been seen over the years that dividend paying companies generally provide stable returns to investors as compared to the non-dividend paying companies. A couple of arguments in favour of non-dividend paying companies could be:

    • Many companies believe that rather than distributing the dividends to its shareholders, it can use the earnings to boost the future growth of the company. It could re-invest in the company to increase its capacity, like is being observed in the manufacturing/commodities sector, or it can make itself technologically advanced, which will help it reduce its cost of operations, similar to the developments in the banking sector. After all, all these are necessary for survival in today's globalised markets.

    • Also, another motive for the companies to retain dividends could be to pay off their existing debts or restructure their existing debts at lower interest rates, which would ultimately lead to increasing the profitability of the company. Retaining earnings would also help the company to avoid borrowings, which in effect would help it keep a tab on its debt servicing commitments.

    However, this was from the companies' point of view. The counterpoint arguments in favour for the investors could be:

    • Why does an investor invest in stocks/equities? To earn, right? And he can earn on equities in only two ways dividends and capital appreciation of the stock price. Now, since the latter is a matter of time and a factor of market perception towards a particular company, the uncertainty factor is always present as regards the capital appreciation of the stock price. However, if the company is consistent in declaring dividends, the investors will feel relatively safer and assured of the fact that irrespective of the market movements, he/she would be earning his bit of share of the company's profits. This is especially beneficial in times when the markets continue to remain lackluster for years as the investor can invest the dividends earned in schemes where he can earn comparatively better than the stock markets.

    • Moreover, investors 'may' start to perceive a company and the sustainability of its earnings with suspicion if a company reduces the quantum of its dividends over the years. This could signal to the investors that the management of the company is not very sure of its earnings capabilities in the future, and hence the dividend reduction, as the company will not be able to sustain the current levels of dividend declarations. However, at the same time it must be noted that very high dividends is also not a good sign as the sustenance of high levels of dividend payouts is not possible. Moreover, high dividends 'could be' due to certain motives. For e.g. PSU companies would declare higher dividends because by virtue of the fact that the government has a major stake in the companies, higher dividend declarations would ultimately fill up their own pockets. Now, here we are not commenting on the fact whether this is an acceptable practice or not!

    In conclusion, investing in a dividend stock is not just about the dividends declared by the company or the dividend yield of the stock. It is also about the company, its management, the business model and fundamentals of the company. The dividend history of the stock is a good indicator of future dividend declarations by the company. However, there is always the likelihood that the dividend declaration trend might not continue or dividends may be curtailed down. But, part exposure to high yield dividend stocks is always likely to assure the investor of a steady income irrespective of the stock market movements.



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