Tomorrow’s payout

Locking funds in dividend-yield stocks could result in missed opportunities to ride on capital appreciation during a bull run

By Mohan Sule

A slowdown is a suitable time to revisit many conventional theories that drive the market. Many times, themes that seemed logical for the market to assign higher discounting during a bull phase go out of fashion during a downturn. Companies unveiling capital expenditure plans are greeted with enthusiasm by investors as these symbolize confidence about future. Capacity expansion is expected to result in higher output. The spurt in the top line is assumed to pull up the bottom line, too. Turn the page, and fall in capacity utilization haunts shareholders. The squeeze in cash-flow not only affects equity ratios but also the ability to service the debt taken up for organic or inorganic growth. Suzlon Energy typifies the incredible rise and fall of companies accompanying the cycles of the market. At the other end is Wockhardt, which is enjoying a second lease of life following the promoters’ relentless cost-cutting initiatives. The lesson is what is good for a company during a market upturn may prove to be its undoing during a bear phase. Take another favorite investment path propounded when the market has caught the cold: scoop dividend-paying companies as they offer comfort during a period when scope for capital appreciation is limited. Besides, the steady steam of income is tax-free. There are two major pitfalls involved with this strategy. The yield decreases if investors, anticipating a dividend, flock to the counter. Those who go by past record to enter a stock may have to wait till the end of the quarter or fiscal year to pluck the dividend. Second, there is no guarantee that these companies would be able to maintain their operating profit as they are present in mature markets, where gaining share can come at the expense of margin. This is what happened to FMCG companies in the last fiscal.

The absence of expansion and diversification limits the attraction of dividend payers during an upturn. Such companies are in the danger of becoming relics. Apple, the most valuable company in the world, announced its intention to pay dividend for the first time and buy back shares in March 2012. Coming soon after the death of its charismatic founder, the market took the move as an indication that the growth machine had run out of innovative products to launch rather than the company’s desire to return some of the cash pile lying idle. Many big FMCG companies outsource chunks of the manufacturing process to retain flexibility during demand push and slump. The suppliers have to sacrifice on margin as their high-volume clients drive a hard bargain. So there is a strange scenario of big manufacturers accumulating cash to pay dividends while the ancillaries face pricing pressure from the end users as well as rising cost of raw materials. In the process, the smaller units may not be in a position to pay dividends. To ensure that investors get a fair deal, companies in safe-haven sectors should invest in their raw material and intermediate suppliers in sectors such as paper and packing, plastic products, glass, printing, and even metals on one hand and in the distribution chain of wholesalers and retailers on the other. This would ensure that satellite producers benefit from the dividend distribution of their large shareholders, who in turn benefit from the growth prospects of their smaller-size suppliers as the capital infusion would enable to update their technology as well as ensure attention and guidance from their shareholders-cum-customers.

Not only investors, even government loves dividend payers. It collects 16.22% dividend distribution tax, an important source of revenue when dwindling volumes and share prices cause a dent in the securities transaction tax and, importantly, tax on corporate profit. This should be small comfort when capital-intensive companies are unable to service their debt and the queue for debt restructuring lengthens. For a country talking of reaping the demographic dividend of more than half the population below 25 years of age, better to have a universe of companies providing employment opportunities and thus creating a consumer class rather a smallish segment distributing dividends. Supporters of dividends argue that the dividend income is a welcome flow of cash in the hands of investors to splurge on consumption. On the contrary, during uncertain times, investors prefer to lock up cash in debt instruments that offer the security of capital protection and high interest rates due to the strain on liquidity despite inefficient post-tax returns. For companies, repaying debt is much more constraining than raising resources through equity issuance. Time perhaps for government, companies and investors to re-look at the issue of dividends to ensure that the cash utilization is efficient and productive.

Mohan Sule