DIVIDEND PAYOUTS – A GOOD INVESTMENT MEASURE?

By Ruma Dubey

Till a few years back, if you asked any of the old time investors about their criteria for making a sound investment decision in stocks, the dividend paying ability figured very high. And now, as all other things have changed, this age-old adage also seems to be undergoing a change. Investors still do look for dividend paying companies but it is not high on the priority list, at least not for the new generation.

It is seen that there are now very few investors who really wait with bated breath for the dividends to come in. And this probably has happened because companies themselves offer very small dividends as against the stock market price. Hence the investor starts looking more at capital appreciation.

But the exact opposite is construed when companies declare very high dividends. In FY18, India Inc saw the highest dividend payout over the last 10 years. The data shows – dividend payout of 457 companies on the BSE 500 index hit 39.6% in 2017-18. This was more than double the 16.5% ration in FY17. FY18 broke the record of FY09 when the dividend payout ratio was 23.19%.

A look at this data too – 71 PSUs were there on the list of 457 companies and their payout ratio surged to 122%, up from 34.1% (YoY).

The highest payout was from Hind Zinc at 1470%, followed by HPCL at 300% and something as innocuous as LEEL Electricals declared 215%.

There is a growing voice of dissent against the high payouts as the thought is that companies declare very high dividends when they do not have better avenues to park their money. It shows the inability of the companies to find suitable investment avenues – like an expansion or buyout or even a logical backward or forward integration. Come to think of it – hasn’t it been a long time since we heard of any company announcing any such new plans? Thus the companies feel it is better to give away the surplus cash to their shareholders. For PSUs – the idea of a higher dividend payout probably emerges from the need for the Govt, its biggest shareholder to fill in their coffers.

Does this mean that dividend as a tool for making investment no longer exists? Like earlier days, can one make all investment decisions based only on dividend payout? There is no denying the fact that dividend is and will remain the best tool to determine the fundamental value of any stock. For long term investors, dividend is the only return which he gets, year after year. And in such cases, dividend-based valuation is the most appropriate to estimate investor’s return.

So how does one calculate this return? Very simple. One can arrive at the return by dividing the expected dividend by the stock price and adding the dividend growth rate to it (expected dividend/stock price + dividend growth rate). And while doing this, it is imperative to remember that when the dividend is negligible, growth rate of the dividend is the determining factor for long-term return.

Does this mean that for a short term investor, dividend holds no relevance? When one looks at short term investment, naturally, capital appreciation is the highest priority. But dividend can become a decisive factor if the dividend yield is high. This dividend yield is arrived at by dividing the last annual dividend with the current price. But there is a stick to this carrot. Dividend yield is a great return only if the price remains at the same level and the company sticks to the same dividend rate. If the dividend rate remains the same but the price goes down then the return is naturally below the dividend yield. And if the price goes up, the return will be higher. Thus in the eventuality of a capital loss, investors cannot earn a return equal to the dividend yield.

If dividend is indeed the criteria for investment then it is imperative to check the dividend history of the company. A company with a long and consistent (if not growing) dividend trend is expected to stick to it in the near future. But if the profits go down, naturally the dividend rates will also come down. Hence while making a decision it is important to take a complete overview of the company and its profit making ability.

Yes, dividend paying ability is an important criterion in deciding on investment but it cannot be the only one. An overall insight into the nature of the company’s business, balance sheet is imperative. The logic is simple – if business is faltering and profits are dipping, naturally dividends will also come down.