Date with dividends

Even if the market as a whole isn't very lucrative for a dividend-seeking investor, there are quite a few companies that offer high dividends.

Rajalakshmi Sivam

It is seen as a sign of a company's financial health and prosperity. It keeps your cash flows steady when the market tanks. Dividends are the portion of the profit that companies share with the shareholders.

India Inc is not a big pay master when it comes to dividend. The dividend yield for the Nifty basket, for instance, is only 1 per cent. That is, for every rupee you invest in the Nifty stocks you only get one paise back as dividends each year.

However, even if the market as a whole isn't very lucrative for a dividend-seeking investor, there are quite a few companies that offer high dividends. SRF, Indian Overseas Bank, Tata Steel and HCL Technologies are some companies, which if you bought last year, would have declared dividends that amounted to 7-14 per cent of your initial investment price. Like a PE ratio, a high dividend yield is a valuation metric that allows you to choose cheap stocks.

Some companies pay dividends semi-annually (called interim dividend) and some annually.

Entitled to dividends?

When a company announces a dividend following the decision taken at its board meet, it sends an intimation to its shareholders. In the intimation letter sent, you would have to keep a note of the ex-dividend and record date.

If you sell the stock before the ex-dividend date, you will lose the dividend. Also, if you think you can make arbitrage profit by buying just buy before the ex-date and selling it after the record date, sorry, post dividend, the price may correct to the extent of dividend.

To be entitled to receive dividend you must be holding the stock on the record date. That is the date by which you should be in the company's records for being entitled to dividend (your share settlement will happen in a day, so buying a day prior to the ex-date will also help).

Consider this: SRF declared an interim dividend of Rs 7 per share on November 4 last year. The ex-date was fixed as November 12 and the record date November 13. Buying the stock before the ex-date and selling it post-dividend will leave you with no additional gains as the price is corrected accordingly. (See table)

Note that not all stocks respond to dividend announcements. That depends on the amount of dividend declared, the yield and other events in the market. In SRF's case, the yield was 4 per cent. If we take REI Agro's example, the stock closed 6 per cent lower on the day following its interim dividend announcement of 10 paise a share (yield: 0.1 per cent). There were no sharp movements on even the day prior to the ex-date.

Dividend percentage and yield

Dividend yield is nothing but the company's annual dividend divided by the stock's current market price. It gives you the return you are likely to earn on the stock (excluding capital appreciation in stock price) on the dividends paid out by the company, remaining same in the next year.

Suppose, you buy a share of Indian Overseas Bank now at the current price of Rs 93. Last year (in FY-09) the company gave a dividend of Rs 4.5 a share. If IOB maintains the same dividend payout this year too and assuming profits too remain the same, your yield or return will be 5 per cent (4.5/93).

When it comes to evaluating dividends, lay investors often get misled by the dividend percentage. It is the yield you should be looking at! Infosys Technologies declared a 200 per cent interim dividend last October. Thrilled was my friend who had bought the company's shares a few weeks back. But, then, the yield calculation left him disappointed.

For anyone who had bought the Infosys' share at the then Rs 2,170, the dividend of Rs 10 a share (200 per cent on the face value of Rs 5), meant a return of just 0.5 per cent. Dividends are always declared on the face value!

High dividend yields often suggest that a stock suffers from a very low valuation, always a reason for caution, especially in a bull market. If there are doubts over a company's prospects, the market would have given it a lower valuation than others in the same business.

Yield, which is a ratio of dividend and market price, may be overstated due to this.

While evaluating yields, therefore, look at other aspects as well — consistency of the payout, the payout ratio and the cash flows enjoyed by the company to gauge if dividends will be sustained.

Dividend payout, which is the percentage of profit paid as dividends, if consistent over a period of time, is a sign of steady growth. Some companies declare bumper dividends in a year on one-time gains (such as sale of investments).

As a mark of celebration too, companies at times reward their investors. In 2006, Infosys declared a special dividend of Rs 30/share (600 per cent on the face value of Rs 5/share) on its completing 25 years in business. NMDC, Tata Power, ICICI Bank, Container Corporation and Indraprastha Gas are companies with stable dividend pay outs over the last five years. PSU stocks are one bunch known for their steady dividend rewards to shareholders.

Should I pay tax on it?

Dividend incomes are not taxed in the hands of the investor who receives them; but at the point of distribution in the hands of the companies. But, again, as the tax is paid only out of the profits of the company, the per share earnings fall and indirectly impact the investors. Companies pay 15 per cent of the distributable profits as dividend distribution tax to the government.