Making sense of dividends

Making sense of dividends







It’s that time of the year when India Inc announces its annual results and rewards its shareholders with dividends. From 100 per cent to 1000 per cent, the rates of dividend do look attractive.

But don’t get carried away. Companies declare dividends as a percentage of the face value of their shares, which may range from Re 1 to Rs 10. So a 100 per cent dividend on a Re 1 share is only worth Rs 10 a share.

Not all companies give away a chunk of their hard-earned profits to its investors.

Some plough it back into business, to generate greater returns from business in the future. But even after having attained scale capabilities, some capex intensive companies are not known to reward shareholders.

For instance, telecom major Bharti Airtel, in spite of being in existence for several years, has only now declared its first dividend.

In these cases, the capital appreciation from the stock price movement has been rewarding that it did not necessitate dividend declaration. In India, consumer non-durables companies, gas, oil marketing companies, and public sector banks are known to declare attractive dividends.

Dividends are seen as a harbinger of corporate prosperity, as it is the most popular route taken to reward investors.

However, this does not imply that all companies that declare dividends may be on a sound business footing. You may need to run a few litmus tests to find out whether such dividends stand to gloss up your portfolio returns.

Dividend Yield


Calculated as the ratio of the annual dividend amount announced and the prevailing market price of the company’s share, the dividend yield ratio shows what investors stand to earn on their shares.

For example, information technology majors Infosys Technologies and Wipro recently declared their annual dividends, of 270 per cent and 200 per cent respectively. But do not go by the mere percentage of dividend announcement since dividends are paid at face value of the stock.

That is, for Infosys (face value of Rs 5) the dividend per share is Rs 13.50, whereas for Wipro (face value Rs 2) it is Rs 4.

However, the dividend yield will be higher for Wipro (1.2 per cent) as its current market price is lower than that of Infosys (0.8 per cent).

While sifting through high dividend stocks, you will also notice that the companies with high promoter holding declare dividends periodically. Apart from public sector companies, others such as Tata Consultancy Services, Sterlite Industries, Reliance Industries, Wipro and HCL, where promoter holdings are 49-75 per cent, declare dividends regularly.

Dividend Coverage


This ratio measures the extent to which a company’s earnings support its dividend payments.

For companies such as Maruti Suzuki and UltraTech Cements, which recently made public their final dividends for the year, the dividend coverage stands at 12-15 times.

This means that these companies’ profits are 12-15 times the amount of dividends declared.

A higher dividend ratio indicates that the company is not straining itself to give away dividends .

Companies such as Hero Honda, Nestle India, Colgate Palmolive and Indraprastha Gas which have minimal debt on their balance-sheets also give away substantial sums as dividends. Final dividends are also a function of the future cash requirements of the company.

Implication for the company


Note that dividends are paid after the board recommendation is accepted by shareholders. So dividend payouts have direct effect on the cash balance of the company.

While it is not mandated by the law to sustain dividend payouts, many companies make it a regular process to retain their value among the investor community.