Dividend policy will help assess companies better

But don't lose out on companies which are ploughing back their profits for growth; have a balanced portfolio

Retail (small) investors should be happy with the Securities and Exchange Board of India's recent decision that India's top 500 companies, by market value, will have to frame a dividend distribution policy and disclose it on their websites.

Both investors and fund managers would be glad with this decision because it gives them a good handle into the company's intent versus actual execution. A Balasubramanian, chief executive officer, Birla SunLife Mutual Funds says: "Such a policy can help in overall assessment of the management quality and be a parameter in the selection criteria. It is, therefore, quite logical to encourage all companies to have such policy and also monitor them from the commitment versus delivery point of view. In other words, intent versus implementation through practice."

What is interesting to note is that direct investors in stocks have not benefited too much from the dividend payout of India's top 20 companies (in terms of dividend paid). In 2015-16, these 20 companies paid as much as Rs 95,275 crore as dividend. Out of this, direct investors in their stocks made just Rs 4,446 crore. Some dividend income also came back to retail investors from their mutual fund and insurance policy investments. That is, mutual funds received Rs 2,722 crore and insurance companies got Rs 7,168 crore as dividend income.

Promoters enjoyed the majority of the dividend largesse at Rs 51,806 crore. Institutions, including foreign and local and non-promoters corporate players, garnered Rs 23,559 crore.

Against this backdrop, the market regulator's decision seems to be encouraging many investment analysts. According to Deven Choksey, managing director, K R Choksey Securities: "From a company's perspective, this is a good move to set accountability standards. Investors would also get direction about a company with a good and consistent record of paying dividends. And the level of confidence in these companies goes up substantially."

  What does it mean for retail investors? High dividend-paying companies are great for retail investors, primarily because of two reasons - one, given its regular paying nature, it gives comfort to an investor who is fixated on regular income instruments such as fixed deposits or small savings schemes. Two, unlike some of the other fixed return instruments, dividend income is tax free in the hands of the investor.

According to Balasubramanian, the dividend policy of companies reflects on the management commitment to the business and sharing of the profit with shareholders. If there is high cash in the balance sheet which is not ploughed back or given to shareholders and instead is used to make treasury gains, the company's valuation would be adversely impacted. "Any such policy as part of the best practice and good governance structure, would help in driving minority shareholders conviction in the ownership of such companies. Many a times, it helps in boosting the valuation too as an indirect benefit to shareholders," adds Balasubramanian.

However, as Hemant Rustagi, CEO, WiseInvest points out, high dividend-paying companies are good for the portfolio but it does not mean that companies that are ploughing back their profits into business are bad. "High dividend-paying companies are considered more stable but someone looking for higher returns will have to take that additional risk in growth companies," adds Rustagi. The focus, therefore, also has to be on the management and other crucial parameters before investing in direct stocks.

Tax benefit on dividend income: If you are paid dividend by the company, the dividend distribution tax is 15 per cent. But it is paid by the company to the tax authorities before the dividend is paid to investors. However, Budget 2016-17 has a new provision - if an individual earns more than Rs 10 lakh in dividend income, there will be an additional tax of 10 per cent. In comparison, returns from fixed deposits are added to your income and taxed, as per the income-tax bracket. While Section 80C gives tax benefits for investing in some of these instruments, the benefit is only at the investing stage, the returns are taxed. For example: If you are investing Rs 30,000 in a five-year fixed deposit and are in the top income tax bracket (30 per cent plus cess), the initial benefit would be Rs 10,000 but the interest income will be taxed.

High dividend-paying company and mutual fund scheme aren't same: Remember this, whereas a regular dividend-paying company shows that its prospects are good and the management is willing to share its profits with the investors, the same does not apply for mutual funds. In fact, a good dividend-paying company may be rewarded by rise in its share price but in case of a mutual fund scheme paying dividends, its net asset value (NAV) goes down commensurately. "Only people who are seeking regular income should invest in such schemes that give regular dividends because the investor is only getting part of the rise in NAV," adds Rustagi.

Most fund houses use this strategy to attract investors and create a positive perception. Sometimes, in an overheated market, fund managers prefer to book regular profits and distribute as it helps reduce the risk for investors if the market corrects suddenly.