“A low capex company with a high cash flow will always give you a higher dividend, something like IT companies. They will always give you a good dividend because their investments on technology and employees are the only two key expenses that they have. Otherwise, whatever profit that they make, they would always want to share it with the stakeholders. Whereas a capital intensive company, something like a company which requires big plant and machinery, a high capex company with a volatile cash flow will give you low dividends and that had been the trend,” says Piyush Chandra, IIFL Securities.
So, let us get the basic idea clear of dividends. It is an attractive proposition, but what does it actually mean and what type of companies are we talking about over here?
Dividend distribution is a very healthy sign both for the companies and for the investors. Because obviously it gives you a lot of confidence that your investments are in good companies because if the company is making profit, obviously, they are declaring dividend and it is more so important because the company has an intent to share the money with the stakeholders. So, getting dividend is very-very important and a healthy sign for the investor. Let us understand the scenario where it is more promising for an investor to receive dividends from a company. Obviously, we are talking about companies who are profitable and who are majorly blue chip companies and people invest in these companies in order to have an extra income and especially the kind of dividend earning companies are a major source of income for people who are retired or the category of senior citizen that is what is preferred most of the times. But then when we are talking about these kind of companies and the earning that they get from the dividend, there are obviously some kind of red flags that might come in different market cycles. If I want to list on these red flags, what would those be?
Obviously, I would not put it as red flags but yes, obviously, there are situations when an investor should be cautious. A low capex company with a high cash flow will always give you a higher dividend, something like IT companies. They will always give you a good dividend because their investments on technology and employees are the only two key expenses that they have. Otherwise, whatever profit that they make, they would always want to share it with the stakeholders. Whereas a capital intensive company, something like a company which requires big plant and machinery, a high capex company with a volatile cash flow will give you low dividends and that had been the trend.
But suddenly, if low capex company, companies which are very capital intensive, starts giving you high dividends, that is, I would not say that is an alarming or a negative sign, but obviously an investor should be a little cautious because the company would need this kind of money for expansion plans and one should look at very closely and monitor that whether this company has other different avenues to invest or is there something else that the investor should be aware of. So, I would not put it as negative but yes investors should be a little cautious about these things.
What about companies where dividends are not paid continuously or where the dividend payout is not sustainable? Is there any way to figure this out that if the company is going on that trajectory?
So, obviously, once you invest in a company, every year you receive the complete commentary from the management. One has to go in detail and understand what does the outlook for the company is and that will give you an idea of where the company is heading and this commentary comes in every quarterly result and annual results of the company. So, if a company is not giving dividends, if they have some apprehensions on giving dividends, I would not say apprehensions but if they are not able to give regular dividends or there are certain constraints the management commentary will give a better picture of what the company is thinking in terms of future prospects.
In a scenario where a company is investing in their growth, do you think that not getting dividend is actually less than ideal for an investor or it is time for the investor to in fact support that company which they will be benefitting for in the future?
So, obviously, in tough times if you have invested in a company, it is not just you have invested in a stock, you have actually bought a part of the business of the company and that we need to understand because when I am actually investing in any company, I am actually co-owning that company.
So, if there are tough times for the company, obviously, as a stakeholder I should be very much aware about it, that is why I said the management commentary is very-very critical part of the whole process because it gives you in depth in terms of what the management is thinking, where the whole company is heading, where the sector is heading, so it will be a part of that.
And once you have a clarity in terms of what the management is thinking, one would know for a fact that whether or not to expect dividend because it will be very wrong on investor’s part also if the company is going through a very tough time to expect dividends from the company.
Now, let us understand an investor who wants to invest in direct equity for dividends and the same investor maybe who is also adopting the same route via mutual funds and via dividend yield funds, what are the advantages or disadvantages for your entire portfolio?
I will put it in a very-very simple way. When I am investing in direct stocks, obviously, I am actually looking out to bet on few businesses that I feel will do well and that is why I am investing in direct stocks. And when I am investing in a bouquet of stocks, which is a mutual fund, I am investing in that portfolio. Obviously, if the portfolio is doing well, the dividends are a byproduct of the performance. And now post the SEBI change, the dividends which are being paid out in mutual funds are being paid out only after booking the profits, so that is again a very healthy sign for an investor of mutual fund because his portfolio is appreciating and when the portfolio is appreciating the fund manager or the investment manager is booking profit from that appreciation and passing on that profit to the investor. So, it is a good and healthy sign in both the ways, if you get dividends from the companies and if you get dividends from mutual funds as well.
What about the tax implication or the tax liability, whether you invest through direct equity or mutual funds?
Dividend income is now a part of your income, it is actually treated as an extra income that you generate on your investment. So, it will be accounted in customer’s taxable income. So, it will be a part of your taxable income.
How many of these kind of funds investor should have in their portfolio and what should be the amount of investment in terms of investment exposure?
A dividend yield fund is basically a fund wherein the investment manager is investing in companies which give regular dividend. So, obviously, when you are investing in a dividend yield fund, the idea is to get regular income. Having said that, when you are investing in a dividend yield fund, there are a few things that you should always keep in mind.
First is the AMC that you are investing with, so pedigree of the AMC is very-very important. Pedigree of the investment manager who is going to actually handle your money is even more critical. You should look at a decent size corpus fund because if you will have a good corpus, only then you will be able to scale up your investment in these kind of companies and obviously, the dividend yield of the entire portfolio. So, when I invest in one or two stocks, I can actually find out the historical dividend yield of that company. But when I am investing in a bouquet of companies, obviously, I need to find out the dividend yield of the entire portfolio. So, these are very critical things when you are investing into a portfolio or a mutual fund. Having said that, as you know, I would refrain from commenting in terms of what kind of dividend yield funds one should invest in.
The idea is because it will depend on the risk appetite of the person who actually wants to invest in. Generally the investor profile for these kind of funds are old, retired people who actually are looking out for regular income in their portfolio and your investment manager, your investment advisor will be the ideal person to tell you which kind of funds you should pick up. I would not take away from the advice that your investment advisor is giving you.