Do dividends really pay?

Anup Menon

ONE does not have to be a keen follower of the stock market to have noticed the sudden change in market sentiment since March 2000.

Deteriorating fundamentals are said to be responsible for the change, and it does seem to be so. The economy, which was in bad shape in 1997-98, recovered somewhat in 1999. But the revival proved short-lived as the economy is again showing signs of strain. With the reversal in fundamentals, market values too suffered a drop.

Finding worthwhile investment candidates is increasingly difficult. Today's winner seems just a recession away from being branded a loser. In this background, could a company's dividend track record offer pointers to stock selection? A dividend track record has for long been seen as a major factor in investment decisions. This is especially true for small investors. A regular dividend payout sends a positive signal to the market, suggesting as it does a capacity to weather the occasional storm.

However, it is equally true that when the economy is under strain, invariably, profitability could also be under pressure. Therefore, managers may prefer to retain the profits and plough them back into the business, in the hope that performance may improve. That means they sacrifice the attribute of a consistent dividend payout record for the sake of growth. So, where does the balance lie?

Business Line carried out an empirical analysis of around 2,000 companies. The findings show that:

*The number of companies paying dividends has declined gradually over the last few years.

*When classified on the basis of payout, the maximum drop was in the companies that paid out less than 9 per cent. While most of the blue-chip companies still remain on the list, the smaller companies gradually moved out.

*The average dividend payout in percentage terms, which initially went up (peaking in 1998), has gradually declined to its 2000 level.

*An industry-wise classification indicates that the FMCG, tea and finance sectors were the top-rankers, based on average payout.

*The technology and oil sectors were the worst performers in the list.

*If dividend payouts are considered a factor in the investment decision, investors have a wider choice of companies to choose from in the FMCG and pharmaceutical segments.

Falling...

The analysis indicated that the number of companies paying out dividend has been gradually falling. For instance, in 1996, around 1,814 companies paid dividends, compared to 615 companies in 2000. The analysis of the frequency distribution of the payout indicates that there has been a drastic fall in the number of companies distributing dividends in all classes.

The biggest fall is in the group of companies having a payout of less than 9 per cent. The number of companies in this category fell from around 206 in 1996 to around 35 in 2000. Over time, many companies, such as Unique Estates, My Fair Lady and GMR Technologies, among others, dropped of the list. The more solid companies in this category include VSNL, Wipro, Hindalco and Nirma, among others.

The decline is least felt in the category where the dividend payout is more than 59 per cent. The decline in this category is only around 26 per cent. Why is this so? In general, the population in this segment consists of fairly well-established companies. For instance, Colgate Palmolive, Hindustan Lever, Ashok Leyland and Reckitt Benckiser, among others.

Payouts: Continuing trend

The average dividend payout has also been declining. The average dividend payout in percentage terms during the period peaked for the year ended 1998, at 76.22 per cent, and since deteriorated to around 38.7 per cent. However, the average value may be skewed on account of extreme observations in the series. Therefore, a more realistic measure would be the median.

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The median numbers indicate that the average payouts in 1998 and 1999 were 34.52 per cent and 34.36 per cent respectively. However, the average payout declined to 31.63 per cent in 2000. This could be an indication that when business conditions improved towards the second half of 1998 and in 1999, companies were more willing to pay more dividends.

Industry composition

The list of companies was further classified on the basis of industry and relative strength in their respective industries. Certain industry segments, such as air-conditioners, engineering, and so on, were left out. This was because the classification was based on the condition that at least three companies from a particular industry must be available for being eligible for inclusion in the final analysis.

Based on this classification we find that the FMCG segment topped the list with an average median payout of around 40.50 per cent, followed by tea and finance, with 37.25 per cent and 36.38 per cent respectively. At the bottom of the list are the oil and technology sectors with average payouts of 22.43 per cent and 21.53 per cent respectively.

The performance of the FMCG industry is interesting. The best performers in this industry are Hindustan Lever, Colgate Palmolive, Cadbury India and ITC, among others. Over the last few years, the performance of the FMCG industry has been more or less stable. For instance, Hindustan Lever is one of those stocks that has the lowest market risk among the bluechips. One reason for the lower risk perception could be the sustained performance.

The fourth place, in terms of average dividend payout, goes to the cement industry. The constituents of this industry included the top guns, namely, Grasim, Gujarat Ambuja Cements, India Cements and Larsen and Toubro. The payout trend was positive for all the constituents, with the exception of Gujarat Ambuja Cements. The cement sector has been witnessing an improvement in terms of offtake, and a hardening of prices. Hence, the earnings performance of most of the majors has been improving. This could have led to the higher level of payout.

In terms of number of constituents, the top spot goes to the pharmaceutical industry. Around 22 companies form part of the list, with an average payout of 30.68 per cent. The list includes some top MNCs, such as Pfizer, Glaxo, E-Merck and Knoll Pharmaceuticals. These apart, domestic majors such as Ranbaxy Laboratories and Dr. Reddy's Labs also find a place.

In most of the pharmaceutical firms, the earnings have been steady, if not rapid. Therefore, the lower level of cyclicality in earnings has helped the company maintain its dividend rates. From an investment perspective, investors also have a wider range of companies to choose from.

Infosys Technologies, Wipro, Satyam Computer Services, NIIT and Silverline Technologies, among others, represent the technology sector. That the category is at the bottom of the list could be on account of two important reasons. First, the industry presents immense growth opportunities for the company. Hence, managers may be of the opinion that they can provide the investor better returns if they plough earnings back into the business. Second, most firms in the industry are facing volatile earnings streams. This could deter them from paying out more dividends.

Summing up

Finally, does investing for dividends pay? (see accompanying story for detailed discussion) The question is simple but the answer may not be straightforward. The final return for the investor is based not on dividend alone. Rather, it is a function of dividends and capital gains.

For instance, in the technology industry, an investor's loss on dividends may be more than adequately compensated by his capital gains. Broadly, a passive investor willing to wait should consider investing in the FMCG or pharmaceutical sectors, which offer a wider array of companies to choose from. But even here, it pays to be selective.