Rethinking dividend yield strategy

Experts see companies favouring a mix of buyback and dividends to reward shareholders, after increase in the dividend tax

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For many years, investors have earned good returns by buying high-dividend stocks. This might need a re-look after the tax of 10 per cent on the gross amount of dividend received by an investor in excess of Rs 10 lakh a year, imposed in the Union Budget 2016. This is in addition to the dividend distribution tax paid by companies.

The result? Many companies have in recent months taken a different route of buyback plans to reward shareholders. Since March, data compiled by Business Standard show, 15 companies have announced plans to buy-back shares totalling almost Rs 24,000 crore; in January and February, only three firms had such plans, totalling Rs 1,721 crore.

Although companies have not spelt out any specific plans on how they plan to reward shareholders, their actions provide an indication.

Of the 15 companies, six have announced buyback to the tune of Rs 14,735 crore in the past two months alone. Another four offers amounting to Rs 4,582 crore have already closed in the past month. This is a sharp jump compared to 2014 and 2015 (calendar years), when 16 and 15 companies announced buyback plans involving a total of Rs 875 crore and Rs 1,725 crore, respectively.

Ajay Bodke, chief portfolio manager at Prabhudas Lilladher, agrees. “Because of the tax issue, there is a clear distortion. Many companies are now favouring the buyback route rather than dividends, as it helps save on taxes,” he says. Adding that even marquee names like Bosch, Wipro, Sun Pharma and Dr Reddy’s have decided to so reward shareholders.

Notably, of the 15 companies, four are government-owned — National Aluminium, NMDC, MOIL and Coal India (combined buy-back amount is Rs 14,876 crore), though their reason for the step would be more to help the government meet its fiscal deficit target.

By no means, however, is anybody suggesting that companies will stop paying dividends. But, experts say the trend of buyback is now straddling across sectors. Although buybacks might not necessarily yield immediate rewards for shareholders, they tend to be more rewarding in the long run, as it reduces the numbers of shares (equity capital), thereby supporting share prices.

Dipen Shah, head of research, Kotak Securities, says: “The trend could be in favour of buybacks this year because of the increase in taxation, though it will be very company-specific. At least for this year, companies are likely to act in favour of buybacks. These also lead to reduction of equity capital.”

This tilt might have a consequence for investors. For one, the importance of dividend yield to evaluate undervalued stocks does get diluted. Investors relying solely on dividends might also need to tweak their investment strategy.

One way is to see rewards like dividends in conjunction with other measures like share buyback etc, suggests Bodke. At the broader level, experts say as India is a ‘growth’ market, investors should focus on companies with healthy prospects, as well as return on shareholders’ funds. Strong fundamentals should yield good rewards in the form of increasing dividends and share price (capital) appreciation over the long run.

Individual investors are not alone. Experts say the trend will also impact the mutual funds. Bodke says it’s an added complexity for funds focused on high dividend stocks. With the mandate so focused, fund managers will have to tweak the criteria and react to this trend.

There is a flip side, too. Deven Choksey, managing director, K R Choksey, says: “It is too early in the year to say how the trend will be, but buy-back will be one option that companies will be looking at. There are also drawbacks with respect to buybacks. Since it will lead to lower floating stock, there will be a limit to how much buyback companies can do. So, it is not a completely viable option on its own. But, yes, for a while, it will be in favour.”

Secondly, not all companies may want to opt for this route. Companies opting for buyback are restricted from raising fresh capital for a period of six months. Third, companies that often require sizeable funds to re-invest in the business to sustain growth are unlikely to go for buyback.

More clarity will emerge once regulations are in place. Choksey says, “Sebi is working on a policy where the top 500 companies will be asked to declare their dividend declaration policy.”