The Enigma of Dividends

This Article was originally published in The Global Analyst

Have you ever invested in a stock to reap dividends? With an average dividend yield of about 1.5% for Nifty 50 stocks, the answer should be a “no”. But the fascination for dividends continues for some unexplained reason.

Dividend is considered a corporate action and therefore share prices tend to adjust based on the quantum of dividends declared. At this stage, it is worthwhile to note that all Nifty 50 companies are dividend payers. However, we cannot assume that companies always pay dividends. We have noticed 13 companies (out of 50) that had some interruptions mainly during COVID years (2020 & 2021). Given the low dividend yield (calculated as gross dividends / market price), it is not uncommon to see some crazy numbers like 15,750% of the face value (Britannia in FY 2021) to beat the low dividend yield. We have noticed that 19 companies (out of 50 in Nifty) declared dividends exceeding 1,000%!

As the financial concept goes, dividends are generally paid out of profits and the unpaid part of profits accrues in retained earnings. Also, declaration and payment of dividends involves cash out flow and companies that are in growth phase may opt to skip dividends and use the profits for expansion. However, most of the Nifty 50 companies are well-settled in terms of their history, profitability and growth and hence declaring dividends has an “Image” value. Investors tend to see dividend paying companies as healthier than otherwise, which may not be true. After the abolition of the dividend distribution tax (DDT), the taxability of dividend income is now in the hands of the investors.?Hence, any outsized payment of dividends will invite tax at the hands of the investor.

The pattern of paying dividends is not uniform even for Nifty 50 companies. We can generally classify the pattern as follows:

1.????? Consistent and Growing: These 22 companies have been consistently paying dividends and have been increasing the quantum of dividends over the years. There is broadly a correlation with price returns of these stocks. The average dividend yield of 1.2% can be explained by the robust price returns but that is only a causal factor. Only one stock (Hero MotoCorp) suffers a negative price return (between 2018 and YTD-2023) but makes it up with a high dividend yield therefore resulting in a positive total return. Interestingly this list is headed by an NBFC (Bajaj Finance) whose dividends have grown by 650% between the period 2018-2023. However, that still results only in a dividend yield of 0.3% due to stock price appreciation. Some companies in the list enjoy reasonably high dividend yield (Power Grid, Hero MotoCorp, ITC, and Tech Mahindra). However, a majority of stocks under this category (14 out of 22) have a dividend yield of less than 1%. In other words, investment interest in these stocks stems more from potential for capital appreciation than dividend yields.

?2.????? Inconsistent but growing: These 18 companies classified under this category have shown a track record of increasing their dividends, but the pattern is not consistent. Because of the inconsistent nature, we can even notice a fall in dividend growth for some companies (Infosys and Bharti Airtel). Except for a few stocks (IndusInd Bank, ONGC, & Maruti Suzuki) that experienced a negative or muted price performance, companies in this category generally enjoy good price and total return. Two public sector stocks (ONGC and NTPC) attract attention in terms of their high dividend yields, though 50% of the companies in this list have dividend yields less than 1%.

3.????? Inconsistent: Three companies from the current Nifty 50 constituents exhibit similar characteristics compared to the previous category in terms of inconsistency, but we have noticed that their dividends have not been growing. The case of Coal India is especially interesting with its mouth-watering dividend yield of 9%!

4.????? Erratic: This list mainly comprises of 7 stocks where there is no discernable pattern in terms of their dividend habits. Some of them enjoyed good dividend growth while others experienced no growth or negative growth. As a group, they also have low price and total returns compared to other categories.

The idea of segregating stocks in terms of their dividend patterns produces some sort of connectivity to those stocks that exhibit consistency vs companies that do not exhibit consistency. Also, while most of the Nifty 50 stocks delivered good price and total returns during the five-year period between 2018 and YTD-2023, it is not very apparent if there is a strong correlation between dividends and performance. A good price performance coupled with good dividend yield is a dream situation but is not practical. High dividend yield will normally be accompanied by poor price returns and vice versa. Based on this analysis dividends can at best account for an additional check box while scrutinizing a company and as said before has more “Image” value than anything else. All else being equal, a consistent and growing dividend paying company should be preferred over inconsistent and erratic dividend paying companies.

Happy Investing!