Investors: Beware of high dividend paying companies

Amidst all the gloom the markets have suffered in the past few weeks, the investor community has something to cheer about with the Union Cabinet's approval of the Companies Bill 2011. This new bill is expected to bring about a better and more competent corporate governance framework, that will strive to make corporate India more investor friendly.

In light of this, we at DSIJ have done an eye-opening analysis of companies that paid exceptional dividend in FY11, with a view to reward their shareholders.

Normally, if a company pays high dividends, the shareholders rejoice and claim that the company is a brilliant investment haven. But have the shareholders ever wondered where these exceptional dividends actually come from. Let us give you an example of Hero MotoCorp, one of India’s leading 2 wheeler manufacturer.

In FY11, the company reported an adjusted PAT of Rs 1813.3 crore and declared an equity dividend of Rs 2096.72 crore. This was despite reporting a 14 per cent decline in the net profit in comparison to FY10.

The dividend yield also stood at a healthy 6 per cent, much to the joy of its shareholders who were still trying to digest and calculate the implications of Honda’s split from Hero.

What’s surprising is that the Dividend Payout Ratio (a function of Equity dividend divided by adjusted PAT) stood at an astonishing 126.39 per cent, implying that the company paid out more in dividend than the profits it generated for the year. In fact we have prepared a list of companies who have paid out more than 100 per cent of their profits as dividend.

Companies having maximum dividend payout ratio in FY11
Company name	Dividend payout Ratio (%)	Equity Dividend	Adjusted PAT	% of share held by promoter (March 2011)
J L Morison (India) Ltd.	1,907.90	0.14	0.01	68.52
Ravalgaon Sugar Farm Ltd.	1,779.87	0.51	0.29	52.88
Acrow India Ltd.	622.94	0.32	0.06	54.52
JM Financial Ltd.	458.49	44.99	20.47	66.86
TRF Ltd.	307.25	2.2	-5.33	39.62
Anjani Portland Cement Ltd.	296.78	1.47	0.74	61.44
Valiant Communications Ltd.	281.46	0.45	0.19	37.23
Hilton Metal Forging Ltd.	224.52	0.31	0.16	51.99
Nitta Gelatin India Ltd.	207.13	3.36	-1.39	80.51
Pradeep Metals Ltd.	206.54	1.48	2.22	42.9
Kanoria Chemicals & Industries Ltd.	192.4	28.15	20.81	57.05
Aptech Ltd.	179.65	12.19	9.34	35.81
Maxwell Industries Ltd.	154.55	0.63	2.03	63.57
Aeonian Investments Company Ltd.	151.54	1.92	1.41	86.96
Heritage Foods (India) Ltd.	143.65	1.38	0.04	45.7
Victoria Mills Ltd.	134.95	0.49	0.4	54.69
Rishabh Digha Steel & Allied Products Ltd.	133.14	1.37	2.34	63.9
Hero MotoCorp Ltd.	126.39	2,096.72	1,813.31	52.21
Bajaj Steel Industries Ltd.	119.35	0.47	0.46	36.62
HCL Infosystems Ltd	115.9	176.3	145.34	51.27
Nitesh Estates Ltd.	106.55	3.44	-1.49	42.48

While most investors would be happy to have earned such high dividends on their investments, they must also take time out to understand where these dividends come from. 

The reasons for such high dividend payout ratios may be many than one can imagine. One of the most apparent reasons could be that the company might pay dividend out of its reserves, but in realty this is not a good practice as far as its future is concerned.

Reserves are usually kept aside by companies to cover for any future contingencies and using them to pay higher dividends in order to please the shareholders does not paint a good picture about its management. Ace investors like Warren Buffet have also emphasized on the fact that a company must try and retain a major part of its profits for future requirements.

If you glance again through the table, you will notice that most of the companies listed above have promoter holding of more than 50 per cent. While it might be reassuring to know that promoters hold a majority stake in their company, which makes an investor feel safe, the possibility also remains that such high dividends might be paid out to the promoters as tax free returns (remember dividends are tax free).

In conclusion, as always we at DSIJ advise our readers to be cautious of such practices. While it is important to closely analyze the financial numbers and ratios of a company, it’s also equally necessary to question and understand the roots of such numbers and ratios.