As every investor knows, the Budget imposed an extra 10 per cent tax on investors who received dividends of over Rs 10 lakh per annum. This affects promoters across India Inc since it has long been more tax-efficient for promoter-chief executive officers of corporates to reward themselves by offering large dividends.
The new tax kicks in from April 1, 2016. Hence, there has been a frantic race through March to declare large interim dividends. This will be a one-time payout. This series of dividends have caused several interesting distortions in the market.
The futures of major market indices were trading at discounts to the cash values because investors were taking delivery of the stocks in the indices, while ignoring the futures in relative terms. This discount to cash is unusual in a market where shares are trending up.
This bonanza ends this week, on Thursday, to be precise. The reactions to the end of this month of big dividend payouts could be very interesting. First, there may be some short-term selling pressure, as investors who have taken their interim dividend get out of those stocks. The ex-dividend prices of many stocks could drop sharply. Balanced against that, if the Reserve Bank of India (RBI) does cut policy rates at its meeting next Tuesday, the market could receive some new bullish impetus.
Of course, the market is already discounting a rate cut to some extent so any rate cut would have to be more than the expected 25 basis points (or accompanied by a bullish policy statement) to push the market up significantly. Even if there is such bullish action by RBI, the end of the dividend bonanza would probably create some selling pressure.
Non rate sensitive stocks which have made large dividend payouts will be more vulnerable to sell-offs, assuming RBI does cut. If RBI does not cut, the bearish pressure exerted by selling ex-dividend stocks might infect the broader market.
The medium-term consequences of the interim dividend payouts could be somewhat serious as well. Normally dividend payouts are made from profits. However, in this case, the special interim dividends have been big payouts that in some cases, exceeded entire profits registered in the first three quarters of 2015-16. Companies have raided their reserves to make the interim dividend payments.
The cheapest form of capital for a company is accumulated profits - this is free. Reserves are very rarely parked in a bank locker. Corporates deploy reserves in their own business or perhaps, in some instrument that earns a decent return. If reserves have been tapped for an interim dividend, financing future investment plans will require corporates to raise capital that is more expensive.
There is a chance also that companies which tapped their own reserves to make interim dividend payments will cut back normal dividend payouts next year. Tapping reserves also affects the debt-equity ratio adversely since equity is reduced. The consequences could be tricky next year for those corporates that cannot generate strong profitability because balance sheets may come under pressure.
It’s hard to predict exactly where this could go because it will be a balancing act for many corporate groups. Making one last big dividend payout before the new tax kicks in, has indeed been a very tempting process. But, the current financial year has been miserable for most corporates and there is little cash to spare.
If there is a big sell off in April in such stocks, that could create some sort of opportunity for value investors. However, in the case of companies, which have stripped reserves to a significant degree, many of next year’s projections will need to be revisited.
The new tax kicks in from April 1, 2016. Hence, there has been a frantic race through March to declare large interim dividends. This will be a one-time payout. This series of dividends have caused several interesting distortions in the market.
The futures of major market indices were trading at discounts to the cash values because investors were taking delivery of the stocks in the indices, while ignoring the futures in relative terms. This discount to cash is unusual in a market where shares are trending up.
This bonanza ends this week, on Thursday, to be precise. The reactions to the end of this month of big dividend payouts could be very interesting. First, there may be some short-term selling pressure, as investors who have taken their interim dividend get out of those stocks. The ex-dividend prices of many stocks could drop sharply. Balanced against that, if the Reserve Bank of India (RBI) does cut policy rates at its meeting next Tuesday, the market could receive some new bullish impetus.
Of course, the market is already discounting a rate cut to some extent so any rate cut would have to be more than the expected 25 basis points (or accompanied by a bullish policy statement) to push the market up significantly. Even if there is such bullish action by RBI, the end of the dividend bonanza would probably create some selling pressure.
Non rate sensitive stocks which have made large dividend payouts will be more vulnerable to sell-offs, assuming RBI does cut. If RBI does not cut, the bearish pressure exerted by selling ex-dividend stocks might infect the broader market.
The medium-term consequences of the interim dividend payouts could be somewhat serious as well. Normally dividend payouts are made from profits. However, in this case, the special interim dividends have been big payouts that in some cases, exceeded entire profits registered in the first three quarters of 2015-16. Companies have raided their reserves to make the interim dividend payments.
The cheapest form of capital for a company is accumulated profits - this is free. Reserves are very rarely parked in a bank locker. Corporates deploy reserves in their own business or perhaps, in some instrument that earns a decent return. If reserves have been tapped for an interim dividend, financing future investment plans will require corporates to raise capital that is more expensive.
There is a chance also that companies which tapped their own reserves to make interim dividend payments will cut back normal dividend payouts next year. Tapping reserves also affects the debt-equity ratio adversely since equity is reduced. The consequences could be tricky next year for those corporates that cannot generate strong profitability because balance sheets may come under pressure.
It’s hard to predict exactly where this could go because it will be a balancing act for many corporate groups. Making one last big dividend payout before the new tax kicks in, has indeed been a very tempting process. But, the current financial year has been miserable for most corporates and there is little cash to spare.
If there is a big sell off in April in such stocks, that could create some sort of opportunity for value investors. However, in the case of companies, which have stripped reserves to a significant degree, many of next year’s projections will need to be revisited.
The author is a technical and equity analyst