Dalal Street Investment Journal

Dividends: The Plus Factor

Consider this - If you had bought 100 shares of HDFC for Rs 66700 at the beginning of FY05, you would have earned Rs 32600 in dividends alone till the end of 2013, which is almost 50 per cent of your investment. This might not look exciting as the annualised returns would come to just about five per cent. But this is not the end of the story. If you would have reinvested the dividends in the same stock, the annualised returns would have almost doubled to nine per cent. Now, that is the power of dividends and its reinvestment in creating wealth for investors. The returns would have been greater had we considered a longer duration. Most investors tend to ignore dividends where they could actually create substantial wealth over a period of time.

Capital appreciation has always been the blue-eyed boy of investment returns. This is despite the fact that various studies have demonstrated the power of dividends especially when they are reinvested. According to a study by Standard & Poor’s (S&P), dividends contribute to more than a third of long-term returns from equity. The fact is reinforced by another study by Barclays Equity Gilt Study which showed that £100 invested in the UK stock market at the end of the Second World War would have been worth £5721 at the end of 2008 if dividends were not reinvested into the market. However, if all dividend payments were reinvested, an investment of £100 would have grown to an impressive £92460.

This holds true even in the Indian context, in both the public and private sectors. Consider a public sector company like Balmer Lawrie Investments which has been a consistent dividends payer since 2003 and has increased it every year since 2008. The total returns provided by the stock including the dividend reinvestment is almost 12 per cent more than the sum total of the capital appreciation and dividend. The difference is likely to increase as the time frame of the study increases. Moreover, this becomes more prominent if the company is consistent in its dividend distribution. There are around 653 BSE listed companies in India that are consistently paying dividends since 2003.[PAGE BREAK]

Sectoral Spread

Is there any trend in terms of consistent dividend payment across sectors or business groups, irrespective of the economic cycle they are in? We considered all 653 companies which have consistently distributed dividends in the last 10 years (from 2004). It does not come as a surprise that the list is topped by the auto and auto ancillary companies, as our last study on this, two years ago, had shown similar results. There are 49 such auto companies. This constitutes 7.5 per cent of the total consistent dividend paying companies. However, if we look at the entire listed space, they form just three per cent. This sector is closely followed by the pharmaceutical sector, which is represented by 48 companies, occupying 4.3 per cent of the listed space. Other major sectors that are consistent in dividend payment are finance (excluding banks), IT and banks.

Moving a step ahead, we tried to find companies and sector that have not only consistently distributed dividends but have also either maintained or increased the dividend percentage per share in the last five years. There are 291 such companies. The pecking order in terms of sector representation changed here as finance and pharmaceutical sector took the lead, representing ten per cent each. This is followed by the banking sector wherein 21 banks have either maintained or increased their dividend payout.

One of the reasons why the list is dominated by the finance sector (including banking), is the good performance of the financial sectors after they were hit by the financial crisis in 2008. The pharmaceutical sector has largely remained immune to the changing business cycle. It thus looks like pharmaceutical companies are the most consistent ones in terms of reliability in dividend payment.

Scratching the surface further, we found that the list of consistent dividend paying companies is fairly dominated by MNCs. While 53 out of the 653 companies are MNCs, PSUs are also not far behind and are represented by 45 companies. Among the business houses, only the Tata Group appears in the list with 18 companies.

The order did not change even when we analysed the companies that have either increased or maintained the dividend percentage in the last five years. It is once again dominated by MNCs with 26 companies followed by PSUs with 25 companies.[PAGE BREAK]

Selecting The Right Dividend Paying Companies

Where is all this discussion leading us to? Selecting the right companies is crucial for investors, especially the ones with a long-term investment horizon. Here are some broad contours on picking the right dividend paying stocks that will help you create wealth over time.

There are two key considerations that you have to take into account for this - looking at the sustainability of the dividend paying capacity of the company and ensuring that the company is not paying amounts that will hamper its long-term growth. Since companies are required to invest in their business in order to grow, higher dividend payment hinders their future growth. There is no thumb rule for the payout ratio and it depends on an individual company and its growth needs. For instance, a company operating in a mature market with high penetration may have higher dividend payout whereas a company functioning in a growing market may shell out lesser dividend.