You are here: Home » Opinion » Editorial » Editorials
Business Standard

Insulating shareholders

Why dividend payouts seem recession-proof

Business Standar Editorial Comment  |  New Delhi 

The last five years have been a washout for Net profit has grown at less than two per cent per annum since 2007-08, while cash flows have repeatedly fallen short of requirements. But hardly felt the pain since most large companies maintained dividends anyway. In the last five years, by all non-bank and financial companies grew at a compounded annual growth rate of 13 per cent. Companies increased their ratio, or the share of recurring net profit distributed as equity dividends to In 2007-08, they distributed a fifth of their net profit as dividends; now, it's nearly a third.

The most obvious reason why companies went out of their way to please is that a recurring and growing plays an important role in reinforcing shareholder faith in these blue-chip firms. Large companies with multiple revenue streams and a balance sheet that gives them access to financial markets are better prepared to navigate an economic downturn than many of their shareholders. Second, corporate profitability is highly cyclical and impacted by factors such as commodity prices, energy cost, salaries and wages, interest rates, and investment cycles - especially in sectors in which both demand and input costs are cyclical, such as commodities, capital goods, real estate, construction and financial services. Managements, however, cannot afford to fully expose their shareholders to these cycles since it will translate into share price volatility and unpredictable cash flows for long-term shareholders. This will make it tough for firms in capital-intensive sectors to raise capital.

In contrast, in industries such as consumer products, information technology and pharmaceuticals, the demand environment is far more stable and business is less capital-intensive. Profit cycles here are flatter and companies can afford to be more lenient in rewarding their shareholders. Ultimately, it boils down to a company's policy. Unlike a bondholder, who enjoys legal protection for her investment, the equity shareholder is a residual beneficiary and managements have complete flexibility. Some, like public sector undertakings or multinational corporations, can front-load it - distribute higher payouts and slow down the pace of reinvestment or depend on financial markets to fund growth plans. Others choose to reinvest and avoid financial markets. Empirical evidence suggests that companies that reinvest profits, such as MRF, Shree Cement, UltraTech Cement, Idea Cellular and Titan Industries, have not only grown faster but have also seen sharper appreciation in their stock price. Still, some did both. Tata Consultancy Services and ITC have rewarded shareholders with higher dividends alongside investing in growth. In the end, perhaps, if any company cannot multiply the money in a difficult investment environment, it should return it to shareholders for better use.

First Published: Sun, December 15 2013. 21:40 IST