When Hero Honda announced a 5,500 per cent dividend per share earlier this year, it not only perked up its shareholders, but also heightened investor interest in companies that pay dividends. Hero Honda isn't an aberration. Several other firms have rewarded their shareholders with high dividends, and as the economy shows signs of improvement, more are expected to follow suit.
Should dividend be considered a parameter while investing in a stock? After all, some companies may announce it to revive their battered share prices, while others may do it at the risk of taking on too much debt or losing out on expansion. To find an answer, we analysed 446 companies that have declared dividends every year over the past five years. We divided these into two groups—companies that have paid high dividends and those that have paid low dividends. In the case of former, the average annual dividend growth in the past three years has been higher than their respective industries. The companies that have had a dividend growth rate lower than their respective industries are considered low payers.
Of the 446 companies, 187 made it to the high dividend list, while 259 were low payers. We also analysed the performance of these firms with respect to the Sensex. Between 2006-7 and 2009-10, the Sensex generated an average return of 10 per cent a year, while the top 58 companies that paid the highest dividends delivered a return of more than 30 per cent a year. In the high paying group, 72 per cent of the companies outperformed the Sensex, while 60 per cent of the low payers underperformed the index. This clearly shows that dividends influence the share prices of the companies. The outperforming group also displayed sound fundamentals in 2009-10. This group's average operating profit growth was 48.8 per cent compared with 28.5 per cent erforming group. Similarly, on the revenue front, the former reported a sales growth of 13.5 per cent compared with the latter's 9.9 per cent.
However, one must remember that some firms pay dividends even if they are not earning adequate profits as they want to attract investor interest. "The companies with high earnings and leverage ratios will be unable to afford large dividend payouts as the profits will be first used to pay the debt on the balance sheet. An investor should buy the stock only if the firm has a sound business model and reasonable growth prospects, coupled with a high dividend yield," says Pallav Sinha, MD and CEO, Fullerton Securities & Wealth Advisors.
To zoom in on such stocks, we filtered 15 firms whose dividend payments rose consistently between March 2006 and March 2010. After comparing their price rise with the BSE 500 Index, only nine companies made it to the final list: Asian Paints, Axis Bank, Bhel, Colgate-Palmolive, HDFC, HDFC Bank, L&T, NTPC and RIL. These have also earned higher returns than the BSE 500.
Dividends can be a steady source of income and investors can consider moving some money from fixed income options to high dividend stocks. If the dividend yield is 8 per cent, it means an investment of Rs 1 lakh will earn Rs 8,000 as annual dividend, which is tax-free. Such stocks are useful in bearish markets as the dividend yield helps contain the losses. If the stock price falls, the dividend yield goes up, making the stock attractive. "Conservative investors could invest more in such stocks," advises Sinha.