The Hindu Business Line : Are dividends worth it?

A friend of mine was gleeful that a 200 per cent dividend had been declared by a company he purchased shares in, a few months earlier. A little while later Rs 4,000 was credited to his account.

He recounted this to me and proceeded to fantasize about a weekend at a hill station or a new mountain bike. He then told me about how the stock had soared by 10 per cent on the dividend declaration.

Being the cynic that I am, I could not stand such joy. So I asked my friend, “How much did you spend on the shares?” “A couple of lakh rupees” was the reply.

He went on to explain how the shares dropped about 40 per cent in the meltdown of the past year, and how the dividend was a shot in the arm. I reminded him, “You do realise the dividend is just 2 per cent of the amount you invested. That barely covers the transaction cost you coughed up on buying the shares.”

He was a little annoyed. Do investors realise how the importance of dividends has waned with stock prices soaring? They probably don’t.

Plunging ‘yield’

Here’s the lowdown. The dividend yield for the Indian markets (as captured by the CNX 500) today hovers at just under 2 per cent!

That is, the “dividend” paid out by an average Indian company hovers at just under 2 per cent of its current market price.

The dividend yield has ranged from 1-2.3 per cent over the last eight years. That shows that investors today buy shares more for their ‘growth’ potential than dividends.

The concept of the dividend has come a long way from being the basis for computing the worth of a share (dividend discount model) and as a means to reward the shareholder.

The dividend was originally thought of as a regular cash incentive for having put your money at risk as a company’s capital.

The inception of security analysis enabled people to ascribe a ‘definite’ price per share. This was based on the value of the underlying assets and other factors. That switched the focus to ‘growth’, how fast a company’s distributable profits grow.

Dividend versus Growth

Companies with hefty dividend payouts are not always the best investments. Certain businesses and situations demand that a chunk of profits be retained to fund expansion and spending.

This may be crucial to maintaining or building a competitive advantage. In such a scenario, the lack of a dividend may not be a ‘minus’ while evaluating a company’s stock.

When looking at the ‘dividend versus growth’ argument, it is necessary to evaluate if retained earnings can generate better returns for you, as an investor, than dividends paid out.

A company’s ability to use the retained earnings (reserves) in ventures which provide an above-average rate of return is the trait to look out for.

What to look for

If you are a conservative investor and do lay much store by dividends, here is what you should look out for:

The dividend yield of the stock at the current market prices. Not the absolute payout. Infosys, for example, paid a 400 per cent dividend on Rs 5 face value (Rs 20). At a share price of Rs 1,600, it works out to 1.25 per cent.

Sustainability. Monsanto India paid a special interim dividend of Rs 120 in addition to Rs 15 annual dividend in 2007-08, out of profits realised from the sale of a business. For 2008-09, it declared a dividend of Rs 12. The sustainability of the dividend is as important as its value.

Companies in cyclical industries may not be able to sustain a consistent dividend. Looking at last years’ dividend to work out the ‘yield’ may be fraught with risk. Metal, automobiles are some of the cyclical industries where dividends could fluctuate with business realities.

It would be prudent for an investor seeking a high dividend return to look at long-term trends in dividend payout as a percentage of earnings or market price, prior to purchasing the company’s shares.

More Stories on : Corporate | Dividend Announcement | Young Investor

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page