Equity investors are often drawn to companies with high dividend payouts, especially when coupled with a consistently high return on equity (ROE) . This combination is perfect. Nevertheless, such companies frequently miss out on the benefits of compounding.
While it may seem lucrative, receiving dividends doesn't always lead to wealth creation. To understand how we studied companies which consistently distribute most of their earnings as dividends. The following filters were used:
-
Market cap above Rs 1,000 crore
-
Median dividend payout ratio exceeding 80 per cent in the last five years
- Median dividend payout less than 60 per cent in previous five years
High dividends have led to low price growth
As growth factor diminished, market has not rewarded shareholders the same as before
| Company | 5Y median dividend payout (%) (FY18-23) | 5Y return (% pa) (FY18-23) | 5Y median dividend payout (%) (FY13-18) | 5Y return (% pa) (FY13-18) | 10Y median ROE |
|---|---|---|---|---|---|
| ITC | 93 | 9.2 | 55.8 | 5.4 | 25.9 |
| Hindustan Zinc | 106.2 | 0.5 | 36.4 | 17 | 23.6 |
| Vedanta | 89 | 0.5 | 15.3 | 5.8 | 21.9 |
| Marico | 82.6 | 11.1 | 56.6 | 25.3 | 37.4 |
| Colgate | 99.8 | 13.6 | 58.4 | 11.7 | 62.8 |
| Sanofi | 175.8 | 5.5 | 46.5 | 19.3 | 19.7 |
| Akzo Nobel | 88.3 | 10.2 | 50.1 | 14.7 | 20.1 |
| P&G Health | 122.1 | 12.2 | 23.1 | 36.6 | 11.9 |
| Esab India | 114.2 | 45 | 5.4 | 18.5 | 15.5 |
| Gujarat Pipavav Port | 94.2 | 3.9 | 40.4 | 17.3 | 12.1 |
| Banco Products | 82.82 | 21.1 | 36.6 | 38.8 | 14.66 |
| Balmer Lawrie | 82.85 | 0.8 | 34.75 | 19.8 | 11.26 |
| Novartis | 113.42 | -0.8 | 32.44 | 13.9 | 7.47 |
| Returns data as of Oct 30, 2023 | |||||
Despite running profitable businesses and maintaining high ROE, 10 out of the 13 companies in the above table generated a significantly lower price return between 2018-2023 as compared to 2013-2018. This coincided with higher dividend payouts in 2018-2023.
So, why do high dividends hinder the future capital appreciation prospects of the company?
Reinvestment of earnings
Dividends come at an expense. They reduce earnings retention for future business growth and capital expenditure. A significantly high dividend payout ratio signals low reinvestment in the business or reliance on debt for capital expenditures.
Low reinvestment usually occurs when management is content with the company's scale or the business landscape offers fewer investment opportunities. As a result, these companies start growing at a relatively slower pace than before, and their price appreciation is also slow. In other words, these companies often mature with saturated market opportunities, grow slower, and experience subdued price appreciation.
What to look out for?
Companies that consistently reinvest in the business are more likely to grow their net worth, often resulting in steady share price growth. However, it doesn't necessarily mean that companies paying high dividends should be dismissed as good investment options, as there are several exceptions.
Consistent financial performance and a robust capability to generate high amounts of free cash flows provide businesses with operational stability. Additionally, shifting market dynamics could present new investment avenues for these companies.
Also watch: What is compounding of returns
This article was originally published on November 01, 2023.
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