It is true that investors put their money in equities for capital appreciation and dividend is not the decision driver. Still, when the market is in a consolidation mode, dividends have a crucial role in the investment portfolio.
Corporate dividends have assumed an important part of the total returns from stock market investment. Over a long term, dividends account for higher weight in total returns; during a slowdown, it consoles investors when stocks give negative returns.
Nilesh Shah, president, corporate banking, Axis Bank, said, “When investors compare returns from equities, they should look at total returns, inclusive of dividend payout.” Total return is calculated after reinvesting dividends.
| SHARE OF DIVIDENDS IN TOTAL RETURNS PIE | ||||
| Absolute* | Dividend | Total** | Share % | |
| BSE Sensex | 11.25 | 6.65 | 17.9 | 37.15 |
| BSE-Midcap | -1.27 | 5.01 | 3.75 | 133.81 |
| BSE-PSU | -1.55 | 7.94 | 6.39 | 124.33 |
| BSE-Bankex | 52.26 | 7.42 | 59.69 | 12.44 |
| BSE-IT | 71.44 | 9.29 | 80.73 | 11.51 |
| BSE-FMCG | 96.2 | 11.84 | 108.04 | 10.96 |
| BSE-Pharma | 72.18 | 5.26 | 77.44 | 6.79 |
| *Absolute returns between March 31, 2008 and March 31, 2012 ** Including share of dividends | ||||
The Business Standard Research Bureau studied the role of dividends in total returns during the economic slowdown period between March 2008 and March 2012. It showed dividends added 6.65 per cent to the total return of 17.9 per cent from Bombay Stock Exchange Sensex companies over these years. While the Sensex was up 1,759 points or 11.25 per cent between March 2008 and 2012, cumulative dividends of Rs 87,304 crore (free-float) for the period by these companies added 6.65 per cent or 1,041 points. We added the cumulative free-float dividends in the free-float market capitalisation of the Sensex companies and used the current base weight factor to work the new index.
The Sensex base weight is adjusted for a change in market capitalisation due to bonus, rights or any other issues of shares. However, there has been no such adjustment factor if a stock goes ex-dividend and so, we have added dividend payout to calculate total return. This is important because the stock price falls when it is ex-dividend but investors get returns.
“Dividends help in countering market risk,” said Tarun Bhatia, senior director, capital markets, CRISIL Research. He said it also helped improve the overall return expected from the equity.
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A study by Morgan Stanley Research show that dividends have accounted for a little over a fifth of the total return from the BSE Sensex over the past decade. The Sensex has been up 390 per cent over the decade. Sensex dividends have compounded annually at a 40 per cent rate. Hence, the total Sensex returns are about 480 per cent or 23 per cent higher than the index return.
Put another way, if the Sensex dividends were reinvested, the Sensex would be at 21,200 instead of its current level of 17,300. For Indian residents, dividends are tax-free and, hence, their contribution to post-tax returns are even higher.
Several mutual funds are found comparing their performance against the benchmark indices and then deciding whether or not they have outperformed. While doing so, it has been found that MFs show their performance where dividends are reinvested but the benchmark indices against which they are comparing returns are not showing total (with dividend) returns.
According to the Morgan Stanley report, dividends are crucial when making investments for many reasons. Most dividend paying companies do so because they have the cash flow, as it acts as a verification of such flow. Rarely can companies sustain dividends by borrowing money.
Apart from being an adjudicator of the quality of earnings, a study indicated dividends are a great valuation tool. Using data since 2005, dividend yield explains three-fourth of the one-year prospective return of the index — no other variable does it so well. MSCI India’s current dividend yield implies a forward return of 40 per cent on the index, based on the relationship between the two over the past seven years.