BOMBAY, 3 February 2003 — Till a few years back, if you asked any of the old time investors for their criteria for making a sound investment decision in stocks, the dividend paying ability figured very high. And now, as all other things have changed, this age-old adage also seems to be undergoing a change. Investors still do look for dividend paying companies but it is not high on the priority list, atleast not for the new generation.
It has been seen that there are now very few who really wait with bated breath for the dividends to come in. And this probably has happened because companies themselves offer very small dividends as against the stock market price. Hence the investor starts looking more at capital appreciation.
And this seems to have brushed off to the companies too which now seem to be fighting shy of paying hefty dividends. Infact the National Stock Exchange (NSE) recently conducted a survey and it was found that the number of companies skipping dividend has risen significantly. The study covers the period from 1990 to 2001 during which such companies have grown sharply from 39.5 percent to 68 percent of all companies listed either on the BSE or the NSE.
It has also been noticed that the number of companies that failed to pay dividend has jumped over 6 times from 674 to 4,237 during the period. During 2001, 3,235 out of 4,766 companies did not pay any dividend.
So what does one do? Stop making investment decisions based on a company’s dividend paying ability? There is no denying the fact that dividend is and will remain the best tool to determine the fundamental value of any stock. For long term investors, dividend is the only return which he gets, year after year. And in such cases, dividend-based valuation is the most appropriate to estimate investor’s return.
So how does one calculate this return? Very simple. One can arrive at the return by dividing the expected dividend by the stock price and adding the dividend growth rate to it (expected dividend/stock price + dividend growth rate). And while doing this, it is imperative to remember that when the dividend is negligible, growth rate of the dividend is the determining factor for long-term return.
Does this mean that for a short term investor, dividend holds no relevance? When one looks at short term investment, naturally, capital appreciation is the highest priority. But dividend can become a decisive factor if the dividend yield is high. This dividend yield is arrived at by dividing the last annual dividend with the current price. But there is a stick to this carrot. Dividend yield is a great return only if the price remains at the same level and the company sticks to the same dividend rate. If the dividend rate remains the same but the price goes down then the return is naturally below the dividend yield. And if the price goes up, the return will be higher. Thus in the eventuality of a capital loss, investors cannot earn a return equal to the dividend yield.
If dividend is indeed the criteria for investment then it is imperative to check the dividend history of the company. A company with a long and consistent (if not growing) dividend trend is expected to stick to it in the near future. But if the profits go down, naturally the dividend rates will also come down. Hence while making a decision it is important to take a complete overview of the company and its profit making ability.
Another trend noticed nowadays is that the gap between dividend yields on common stock and the interest rate on bank deposits has narrowed down considerably, forcing investors to look out for high dividend paying stocks. In 1996, the gap between dividend yield and the State Bank of India’s 1-year deposit rates was around 9 percent which has now come down to around 4 percent. Also with the Kelkar committee recommending exemption of dividend tax in the hands of share holders and abolishing the withholding tax on dividends by companies, there is no doubt that dividend will remain a decisive factor. Analysts confer that it is indeed the best tool as debt returns have come down drastically in the last three years. The government securities are yielding close to six percent. Dividends give better returns and carry the upside of capital appreciation.
The new generation may think dividend is outdated and is for the oldies but very soon, they too will realize that like always, old is gold. Undeniably, dividends will continue to remain a high priority while making investment decisions.