Your investment in equity shares can reward you in two ways—price appreciation and dividends. Although this is true in theory, more often than not, investors buy stocks for capital appreciation. However, when the economic growth comes under pressure and corporate profits don’t rise quickly; shares don’t rise as rapidly as investors might expect.

Equity markets jumped significantly after NDA Government came to power; but after the initial phase of the sharp movement, the rally fizzled out due to sluggish corporate performance. In such times, companies have tried pacifying shareholders by paying them higher dividends.

The question is will higher dividends sustain if corporate Inc. doesn’t see any significant jump in revenues and profits in foreseeable future?

As reported by Business Standard on May 02, 2016, out of 144 listed companies that have reported their Q4 numbers so far are set to pay dividends of Rs 61,087 collective for the Financial Year (FY) ended March 31, 2016. This has been a jump of 19.2% over the amount they paid as a dividend in FY 2014-15. The said 144 companies will retain 57% of their profits and the remaining 43% will be distributed to shareholders as a dividend. Last year the retention was 62%. The net profit of the sample companies has increased at a compounded annualized rate of 8.0% over last five years. However, the growth in dividend has been over 26% during the same period.

Will Higher Payouts Make Dividend Yields Less Attractive?

(Source: BSE, PersonalFN Research)
S&P BSE Sensex constituting companies have also demonstrated the similar trend of higher payouts. However, the difference in the net profit growth and dividend payout growth is lower. Sensex companies have recorded 13% growth in their dividend payout while their net profits have grown at 7.5% over last five years. A few companies are paying as high as 80% of their net profit for FY 2015-16 as dividends.

Higher dividends at a time when there’s no significant growth in earnings suggest you two things

1. Companies are trying to reward shareholders that have stayed with it even in tough times.
2. There’s no immediate requirement for funds. So, no significant expansion plans.

What’s been the impact of higher dividends?
Higher dividends have considerably improved the dividend yields of many stocks thereby supporting valuations. Now the challenge for these companies would be to maintain the same pace in dividend payouts and higher yields as the stock prices have also run up in last couple of years. Unless revenues and profits of companies grow, high valuations of many of them will be under pressure, and stock might go down accordingly.

Should you consider dividend yield funds at this juncture?
You should avoid investing in thematic funds, although dividend yield funds broadly follow the tenets of value investing and thus have a better risk profile than other thematic funds. Equity diversified fund with no market capitalization or style bias may consider attractive dividend yields if there’s any merit in the underlying business.

In brief :
Although higher payout ratio and higher dividend yields are good indicators of value, you should avoid misinterpreting them as bargains, especially in the case of companies that have experienced slow profit growth. A sudden and unforeseen drop in profits may make things worse for these enterprises. Cheap valuations may start looking extremely expensive all of a sudden. Never follow any indicator in isolation.

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