Compounding Shareholder Returns:If you invest in the stock market or equity, then you must have often heard the discussion of dividends. Some companies give a part of their profits to their investors in the form of dividends. This makes it clear that mostly those companies distribute dividends which are themselves in profit. The advantage of investing in such shares is that investors can earn profits in two ways. It can be said that dividends can prove to be the hidden gem in adding the power of compounding to the returns of a shareholder. Let us know how investors can get double benefit from dividends.
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Adds extra return to the return
Shiv Chanani, Senior Manager-Equity, Baroda BNP Paribas Mutual Fund says that dividend is a very important aspect in increasing the profits of investors. To understand this thing more clearly, you can see that the Nifty 500 index has had a compounding growth of 12.5% from January 2000 to July 2024, while the Nifty 500 TRI index (total return index which includes dividend payments) has grown at a compounding rate of 14.2% during this period. It is clear here that the dividend has added an additional 1.7% return on top of the return.
If one had invested Rs 1 lakh in Nifty 500 TRI in January 2000, its value would have now become Rs 26 lakh, while an investment of Rs 1 lakh in Nifty 500 index during this period would have become Rs 18 lakh (without dividends). Dividends alone have contributed more than 30 per cent to total returns in the last 24 years. Therefore, while growth is the cornerstone of equity investing in India, ignoring the contribution of dividends to total returns can be a grave mistake.
(Source: Data as of July 31, 2024. MFI and internal research.)
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Profit making companies pay dividends
Shiv Chanani says that companies paying dividends consistently is an indicator that those companies are showing consistent growth and making profits. Dividend payments are the biggest indicator of a company’s ability to be cash rich and consistently make profits. As we know, most companies require capital for growth and expansion and there are only three sources of capital available – fresh equity, debt and internal accruals. If a company has to grow consistently over time, it will need to generate free cash flow consistently. Consistent dividend payments ensure the company’s success in achieving the ability to consistently generate the predicted free cash flow.
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Less affected by market fluctuations
Another key characteristic of dividend paying companies is that the stocks of these companies are generally less volatile than the overall market when it comes to share price fluctuations. More importantly, the stocks of these companies are less likely to see sharp declines. In fact, our research shows that the beta of Nifty Dividend Opportunity 50 TRI compared to the Nifty 50 index is 0.82 over the last 5 years. (Source: Data as on 31 July 2024. MFI and internal research.)
Every company with every market cap pays dividend
Shiv Chanani says that there is a misconception that better dividend yields will be associated with companies with low returns and low growth. This is not true. There is no need to make a trade-off between growth and consistent dividend payments. Investors can consider dividend-paying companies to be of the same quality as a skilled batsman. A good batsman not only has the ability to hit the ball out of the boundary line, but also has the ability to take singles and score runs to strengthen the innings. Similarly, dividend-paying companies help in increasing returns not only through the increase in stock price, but also through consistent dividend payments over time.
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Talking about misconceptions, some investors may also think that dividends are paid only by large companies. These are myths and misconceptions. Dividends are being paid by companies with different market caps including mid-cap and small-cap companies. Also, companies from different sectors including the capital incentive sector are known to pay dividends. Investors should understand that dividends play an important role in returns, especially when they are compounded over a long period of time.
How to get double benefit from dividend
Suppose you have 5,000 shares of a company and you have invested Rs 20,00,000 in them at the rate of Rs 400 per share. If the annual return of these shares is 18 percent and the company has decided to give a dividend of Rs 12 per share to the investors.
Total Shares: 5,000
Total Investment: 20,00,000 (Rs 20 lakh)
1 year return: 15%
Return on Investment: Rs 3,00,000
Dividend: Rs 12 per share
Total Dividend: Rs 60,000
Total profit: Rs 3,00,000 + 60,000 = Rs 3,60,000
