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There was a Tsunami of dividends announced in the month of March 2016. Corporates were rushing to pay dividends. The reason - Mr Jaitley introducing a 10% tax on individuals with dividend income of more than Rs 10 lakh per annum post 1 April 2016 in the Union Budget.
Going by data compiled by Capitaline on 9 March, around 275 companies decided to pay interim dividends post this announcement. The count would be significantly higher since. The latest company to announce dividend is Hindustan Zinc. It declared a special golden jubilee dividend amounting to a cash outflow of Rs 122 billion - including dividend distribution tax (DDT). Considering that the company paid a cumulative dividend of Rs 226 billion in the preceding fourteen years, this year's figure is definitely a massive number.
The rush to pay interim dividend is intended to beat the new tax introduced by the budget. However, should intentions to pay dividends be driven by tax planning? Certainly not. The decision to pay dividends should be based on the future expansion plans, rate of return on retained profits and cash flows. However, where one could raise a red flag is when companies dip into their reserves to pay dividends; this could lead to a possible cash crunch situation leading companies to take on debt instead. Not to mention the stress on debt-equity ratios that could arise as a result of this move.
After all, the decision to pay dividends should boil down to opportunity costs. If the rate of return on retained profits is expected to be high, more emphasis should be given to doing so. For eg: if a company is eyeing an expansion plan which can give it returns way higher than its cost of capital, then it should retain profits.
We are in no way saying that dividends are bad. After all, they provide protection against downside risks. Dividend income, unless consistent and from a fundamentally strong company, hardly compensates for the risk of investing in stocks. Rather than arbitrarily investing in dividend stocks, what one should do is to buy the most solid, consistent, and fastest-growing dividend companies - something that we like to call 'Dividend Multibaggers'.
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