Reinvesting dividends makes sense if the requirement of money is not immediate, and dividend should be used for liquidity management
The extra-ordinary dividend of Rs29 per share announced by Coal India has brought the word, ‘dividend’ to limelight once again. This is not for the first that time dividend has hogged headlines. Recently, Strides Arcolab issued dividends, which looked like a company winding up its operations and distributing the entire money to shareholders.
The Strides Arcolab announced Rs500 per share dividend. Investors have often chased high dividend yield shares. Historically, much has been written about dividends and its significance under different approaches, from dividend discount model to Miller-Modigliani approach.
So what does dividend mean for investors and how should investors analyse dividend in the process of investing?
The first step in understanding dividend is to understand the dividend policy of a company. The dividend policy will help an investor get an idea about what kind of dividend he should expect from the company. While every company many not have a well documented dividend policy, many investor-friendly company have these policies in place and an investor must go through this policy to understand what to expect from the company. Even in cases where a company does not have a well drafted dividend policy, past trends can give a good indication of what to expect from the company. Here are details of some companies which have a well drafted dividend policy.
Name of the Company | Dividend Policy |
Profit making Public Sector Undertaking | As per the guideline dated February 11, 1998 from the Government of India, all profit-making PSUs which are essentially commercial enterprises should declare the higher of a minimum dividend of 20% on equity or a minimum dividend payout of 20% of post-tax profit. The minimum dividend pay-out in respect of enterprises in the oil, petroleum, chemical and other infrastructure sectors such as us should be 30% of post-tax profits. |
HDFC Bank | HDFC Bank has had a dividend policy that balances the dual objectives of appropriately rewarding shareholders through dividends and retaining capital in order to maintain a healthy capital adequacy ratio to support future growth. It has had a consistent track record of moderate but steady increases in dividend declarations over its history with the dividend payout ratio ranging between 20% and 25%. |
Infosys Ltd. | Currently, Infosys pays dividends to its shareholders. The current dividend policy is to distribute not more than 30% of the PAT (consolidated Indian GAAP) as dividend. The Board of Directors reviews the dividend policy periodically and on 15 April 2008 decided to hike the dividend policy to up to 30% of post-tax profits from 20% of post-tax profits earlier |
CRISIL Ltd | CRISIL believes in maintaining a fair balance between cash retention and dividend distribution. Cash retention is required to finance acquisitions and future growth, and also as a means to meet any unforeseen contingency. CRISIL has also been conscious of the need to maintain stability in its dividend payout over the years. From 2008, CRISIL has commenced the practice of paying dividend on a quarterly basis. |
Larsen and Toubro | The board of directors reviews the dividend policy periodically. L&T pays a dividend because the company’s investors in India and abroad view this as an important market signal of the management’s confidence in the future. |
Source: Websites of respective companies
After having understood the dividend policy, an investor needs to understand how the dividend decision of a company impacts its share price. Very often, after an extra-ordinary dividend is announced, the concerned company’s share prices tend to go up after the announcement. Coal India shares experienced this. While this may not hold true in all cases, a company surprising investors with dividend on positive side tend to add value for investors in share price in many cases. Some of the theoretical approaches on the significance of the dividend confirm the positive influence of dividend on share price. MJ Gordon, in his dividend discount model (also known as Gordon growth model) believes that paying large dividends reduces risk and thus influence stock price, while another analyst Baskin (Baskin, 1989) says dividend is a proxy for the future earnings. An investor also needs to pay attention to dividend yield which is a relationship between dividend per share and the price of the share. Here also an occasional high dividend yield may not serve much purpose and consistency once again is the key.
Another important aspect that an investor needs to understand is where to deploy dividend proceeds. Ideally dividend can be utilized for meeting working capital requirement of one’s life. While reinvesting dividend makes sense if the requirement of money is not immediate, dividend should be used for liquidity management by an individual. In case of companies which have well drafted dividend policy, cash flow from dividend is relatively stable and helps in financial planning process. Along with other intermittent cash flows such as coupon or bank interest, an investor can combine money received from dividend to plan his finances well.
(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)
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