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Do dividends affect stock returns?

Do dividends affect stock returns?
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Dividends hold a vital role in stock investing, serving as a way for companies to distribute a portion of their earnings to shareholders. When a company pays dividends, it signifies its willingness to share its profits with investors. Hence, they are often viewed as a measure of a company’s growth and profitability and its commitment to rewarding shareholders.

Consequently, it is not uncommon for a generous dividend announcement to impact a stock’s price. Given these observations, I wanted to evaluate the hypothesis: do dividends affect stock returns? 

Research Methodology

To conduct this study we needed to check dividend per share data and price performance over a long period of time. This was to ensure that the study accounted for business as well as stock market cycles. Hence we decided to only include companies that have been listed on NSE at least since 1st Jan 2010. Out of 2038 companies currently listed on NSE, 992 companies met this criterion and were included in the study.

The first step was gathering the dividend per share paid out by these companies between FY2010 and FY2022. Data for FY2023 was not considered, as dividend data for all companies, has not been released yet. All dividends per share paid during a financial year, including interim and final dividends, were included in this analysis. Stock price returns indicate compounded returns between 1st Jan 2010 and 30th April 20203.  

Consistency of dividends and stock returns 

First, let’s understand how the consistency of dividend payouts affects stock price returns. During the 13-year period from FY2010 to FY2022, we studied the pattern of dividend payouts. 

What were the findings? Companies paying consistent dividends outperformed their inconsistent counterparts.

Companies that never paid dividends, during the study period, reported a median return of 1.4%. Interestingly, not paying dividends is better than irregular dividend payments since companies that paid dividends six times or fewer in a span of 13 years achieved a median return of a mere 0.4%. This emphasizes the importance of consistency in dividend payments.

On the flip side, companies that exhibited a higher frequency of dividend payments displayed significantly better results. Those that paid dividends seven times or more during the study period boasted a median return of ~13%. However, the most favourable outcome was observed in companies that paid dividends in all 13 years, with the highest median return of 14.1%. 

These results suggest that companies that consistently pay dividends have the potential to outperform companies that don’t pay dividends consistently.

Growth of dividends and stock returns

Next, the impact of increasing dividends per share on stock returns was studied. The growth streak refers to the consecutive number of years in which a company has increased its dividends per share. For example, if a company increases its dividends per share for three consecutive years (FY10, FY11, and FY12), it has a growth streak of three. 

The more consistent the dividend growth, the better the stock return

Only 6 companies, namely Reliance Industries Ltd., Berger Paints India Ltd., Pidilite Industries Ltd., ITC Ltd, Asian Paints Ltd, and Sundaram Finance Ltd, achieved constant growth in dividends per share each year between FY2010 – FY2022. During the period under study the median stock price returns of these 6 companies was ~23%. Constant growth in dividends per share indicates that the companies were able to increase dividends per share for 13 straight years.  

Their exceptional stock performance underscores the significance of consistent dividend growth.

In contrast, 275 companies that failed to increase dividends year-on-year reported a modest return of 0.41%. These 275 companies had at least one of these characteristics –

  1. Their dividend per share was constant throughout the 13-year period (FY10 to FY22)
  2. Their dividend per share never increased in two consecutive years
  3. They never paid dividends

Additionally, companies that had a dividend streak of 7+ years had median returns of 16.16%, while companies with less than 6 years of streak had median returns of 6.2%.

Which sectors have the most generous dividend payouts? 

Finally, the dividend consistency and growth in different sectors were analyzed. 

The first parameter of analysis was the consistency of dividend payouts. Since the period under study was 13 years, companies with dividend payouts in 7 years or more (almost half of the 13 years) were considered consistent. 

Additionally, year-on-year increases in dividends per share were the second parameter.

Sector % of companies with 7 or more dividend payouts since 2010 % of companies with y-o-y dividend growth
Utilities 72.7% 45.5%
Materials 71.9% 24.6%
Energy 69.6% 34.8%
Health Care 68.3% 28.6%
Financials 66.7% 32.2%
Industrials 64.1% 18.2%
Consumer Discretionary 61.9% 26.0%
Consumer Staples 61.4% 25.7%
Information Technology 51.3% 21.8%
Communication Services 44.2% 14.0%
Real Estate 52.9% 8.8%

Companies in the utility sector emerged as the top sector in terms of regular and growing dividend payouts. ~72.7% of utility companies paid dividends seven times or more in the past 13 years, with 45% consistently increasing dividends. 

In India, utility companies are involved in services such as electricity and gas production and distribution. Globally, utility companies are known for their stability and consistent dividend payments. This trend seems to be followed in India as well.

Conversely, sectors like real estate have faced challenges in dividend payouts. Only 50% of real estate companies have paid regular dividends and only 20% have paid growing dividends. Though the sector’s long-term prospects remain strong, factors such as demonetisation, the IIFL crisis and COVID-19 lockdowns, among others, have negatively impacted its growth and ability to distribute dividends.

Our Dividend smallcases

The image above refers to the 3 dividend smallcases managed by Windmill Capital. You might be wondering, if all these are one and the same, it is not the case. The underlying strategy remains dividends, however, there are different aspects of dividends that we choose for different smallcases. From a market cap perspective, Dividend Stars is a small & mid cap-heavy basket whereas Dividend Aristocrats is a large cap heavy. As Dividend Stars takes into account the average dividend yield, more mid & small-cap stocks get selected as they are priced lower. And with Dividend – Smart Beta has its selection universe from the top 150 companies by market cap, the allocation is heavy towards large-cap companies. 

With respect to diversification,  Dividend – Smart Beta focuses on a short-term dividend streak (5 years) as compared to Dividend Aristocrats which focus on a long-term dividend streak (10 years). As a result, the former is usually more diversified. 

In case you are interested to have a better understanding of all 3 dividend smallcases, please read here

The takeaway

In conclusion, it is evident that dividend-paying stocks have the potential to outperform their non-dividend-paying counterparts. While dividends may appear modest in a given year, their compounding effect and long-term impact on stock returns should not be underestimated. Consistent dividend payouts and growth can be an indicator of a company’s positive trajectory, and investors can consider dividends as a factor when constructing their portfolios. 

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