Personal Finance

Do dividends make a difference?

Aarati Krishnan | Updated on January 20, 2019 Published on January 20, 2019

Dividends added 1-2 percentage points to equity returns over 10 years

Most Indian investors buy stocks hoping to create mega wealth from capital appreciation. Investing for dividends, they feel, is for wimpy folk. They’re also convinced that only mature companies in the sunset of their lives will pay high dividends, while ‘good’ companies reinvest every rupee of their profits into business expansion.

But a study of the BSE 500 companies over the past 10 years shows that investors could be losing out significantly by holding on to such mistaken notions.

Dividends boost returns

Bloomberg data (as of December 16) tell us that the S&P BSE 500 index is up 323 per cent (12.4 per cent CAGR) over the last 10 years, based on the price gains of its constituents. But the total return from the index, including dividends, was 387 per cent (14.4 per cent CAGR).

Therefore, dividends added as much as 64 percentage points to the corpus of the investor who put money in the BSE 500 in the past 10 years. Data for the Nifty 50 is equally compelling. The Nifty 50’s total return, including dividends, is 344 per cent (13.1 per cent CAGR) over the past decade, way ahead of its price return of 285 per cent (11 per cent).

If dividends have made a notable difference to equity returns in the last 10 years, they are set to make an even bigger difference for your wealth-creation plans in the next 10 years, if those equity returns moderate.

Growth stocks with dividend

While the total returns show that dividends added 1-2 percentage points to long-term equity returns from the market as a whole, there are individual companies where they contributed much more.

For instance, an investor who bought a share of TVS Srichakra tyres in March 2009 at ₹57 has earned dividends totalling ₹248 per share from the company in the last 10 years (this is a simple total of dividends without considering the time value of money). Hexaware Technologies, acquired at ₹19 in March 2009, has paid back ₹53.5 as dividends over a decade. Oracle Financial, which traded at ₹457 10 years ago, has paid ₹1,065 as total dividends since then.

Companies that have paid the highest absolute dividends in the past 10 years aren’t really mature, slow-growing businesses as most people assume. Instead, many of them are growth companies that have also been star wealth creators of the past decade.

For instance, Page Industries, which traded at ₹306 in March 2009, not only saw its stock price zoom to ₹23,700 by March 2019, but it also paid out ₹596 in total dividends over 10 years from 2009 to 2019. Eicher Motors, which ruled at ₹237 in March 2009, paid out ₹449 as dividends over the last 10 years even as its stock price zoomed to ₹20,600. Bajaj Finance, which traded at ₹60 then, paid ₹112 as total dividends, while its stock price surged to ₹2,599.

But for investors to have really earned those returns, they should have kept track of their annual dividend receipts and reinvested in the same share. It is unlikely that many investors actually did this, given that most of us do not have segregated bank accounts for our equity dividends.

The lesson, therefore, is to ensure that your dividend credits land into a demarcated bank account so that you can systematically reinvest it.

Indian investors should also not treat growth- and dividend-investing as two conflicting styles of stock-picking.

Dividend-seeking investors, instead of looking only at current dividend yield (the latest dividend per share divided by stock price) to make portfolio choices, should be paying more attention to the company’s business prospects, profit growth and payout policy for a holistic view.

Investors who picked conventional dividend yield favourites such as Allahabad Bank, Indian Bank, Corporation Bank, PFC and GE Shipping in March 2009 not just earned very poor stock-price returns in 10 years, but also pocketed lower dividends for every rupee invested, than those in the above growth stocks.

Growth investors, in contrast, should be adding the dividend history of companies to their checklists for screening stocks, which today consist mainly of profit growth, return on equity, cash flow and debt parameters.

Assess dividend potential

So, how does one home in on growth stocks with high dividend potential?

One, the nature of the business matters. Industries that have high profit margins generate high returns on equity and don’t need regular injections of cash (say, technology, FMCG, automobiles) to scale up.

They are usually in a far better position to pay out rising dividends, than capital-guzzling businesses such as banks, infrastructure or NBFCs.

Two, irrespective of the industry, the attitude of the management towards sharing profits with shareholders makes a big difference. Coromandel International has been a prodigious dividend-payer over the years despite being in the volatile agri-inputs space. Colgate and Hindustan Unilever have made up for their not-so-fast-growing core business through liberal dividend policies.

Finally, check out the dividend history of a company for consistent payouts, through the good and the bad times. Look for a dividend payout ratio of 50-plus per cent.

SEBI requires the top 500 companies to disclose dividend distribution policies on their websites, and you can read them for cues to future payouts.

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