Dividends can be more valuable as indicators of financial health than as a source of returns
08-Nov-2019 •Dhirendra Kumar
A few weeks ago, I came across a great example of equity investors' blindness to the huge impact that dividends can have on equity returns. I came across a tweet from a financial advisor who lamented the fact that after exactly five years, a particular big-name stock was at exactly the same level. It was a coincidence and didn't look like a happy one. However, it seemed like an odd thing because although I hadn't looked at this company closely, my impression was that it was a reasonable dividend payer.
So I entered the purchase into the Portfolio Manager on the Value Research website and checked the returns. Our Portfolio Manager automatically looks up and applies all bonuses and dividends automatically and calculates the effective returns. It turned out that this five-year investment, which looked like a dud because the stock price was at exactly the same level, would actually have resulted in a 12 per cent total gain over the period. Of course, this was before the recent bump in stock prices, so now the number is up to 20 percent.
For five years, 12 per cent is not a great number, amounting to just 2.5 percent per annum. However, there are a number of interesting points here. One is obvious, which is that in a matter of just four trading days, that 12 per cent became much higher, which is the whole point of equity investments. Any particular point-to-point comparison can be selected to prove anything and the markets can quickly make that irrelevant. However, all of us who invest in equities already know that. My topic of the day is not these variations but dividends.
Despite the fact that this stock's quoted price stayed stagnant for five years, investors got a fifth of their investment back because the company paid dividends regularly. Mind you, this is not a stock with a high dividend yield. Instead, what we have here is a long and consistent history of regular dividend payments.
Traditionally, going by the theory of dividend-centric equity investing, a high dividend yield is the metric to chase. However, with experience in the real world of Indian investing, we don't quite agree. Dividend yield is the result of a skewed ratio of dividend and the stock price. Its root cause is almost always a stock price that's too low and the question to ask is why it is too low. More often than not, the stock price is low for some good reason, some big negative in the company. However, if the dividend is a reasonable ratio to the fundamentals (not the price) of a company and that dividend is paid consistently, then that's a strong positive signal about the financial health of the business and an indicator of the stock being a possible investment candidate.
It's unfortunate that India's equity investment culture pays less and less attention to dividends. Much of the reason is of course perennial short-termism. Since most investors (and investment advisors, as is obvious from the story above) have an investment horizon measured in weeks or months, the idea that dividends are a part of returns doesn't enter their calculations often. Investors are so focused on short-term price appreciation that the value of sustained dividend payouts, both as returns and as a signal, is not part of their circle of attention.