What is Dividend Policy

The board of directors have the actual power to declare dividends. The board also decides the proportion of profits to be distributed by way dividends. This is the dividend payout ratio. I am a value investor. To me, the dividend is very important. I consider dividend as investor's wage. Therefore I would like to know what the dividend policy of the company is.

Dividend Policy - Definition

It means the longterm belief or commitment or view guidelines of the company's management towards distributing the profits of the company to its shareholders by way of dividends. The policy will state under what circumstances can the shareholders expect or not expect dividends. It will also state the financial standards the management will use to decide the dividend.

I discuss the topic only in the context of dividends belonging to equity shareholders, even though the word dividend includes dividends attached to preference shares also,

As I mentioned earlier the power to declare the dividend rests in the hands of the board of directors of a company. Until recently companies were neither required to declare their dividend policy nor they did voluntarily. Boards followed their own rules. Some managements showed a longterm trend of paying handsome dividends. Some boards never paid a penny. Ans some other were stingy in paying dividends.

Things started changing for the good from the year 2016. Finally, the Securities and Exchange Board of India (SEBI) issued guidelines. The government of India also issued an internal circular to companies in which it had major holdings regarding dividend distribution.

SEBI Guideline

SEBI Issued guidelines in July 2016. According to this the top 500 listed companies by their market capitalisation shall:

• Formulate a dividend policy and
• Publish it in the companies' annual reports and display it on the corporate websites
• The policy shall state the circumstance under which an investor may expect or not expect dividends as well as financial parameters used in deciding the declaration of dividends.

The market capitalisation as on 31st March of every calendar year will decide the top 500 companies.

It also encourages other listed companies not falling in the top 500 bracket to follow the guidance voluntarily.

You can download the full notification by clicking here.

Government Circular to Public Sector Companies

The ministry of finance, the government of India issued an office memorandum. It applies to all central public sector companies (companies in which the government has majority shareholding). The memorandum relates dividend policy.

Accordingly, this circular requires:

• The boards shall continue to have autonomy relating to operational matters, as usual
• The government views the declaration of dividends is rather a policy matter
• Therefore, as a major shareholder, the government has a clear say in deciding the dividend to be declared

Building further on the ownership logic the circular requires that:

• A public company shall pay either 30% of the profits or 30% of the equity investment whichever is higher as dividend
• The company shall pay special dividend where there is surplus cash
• Similarly, the company shall consider issuing bonus shares where there are excess cash reserves
• Company shall not fund expansion plans solely through profits but the companies shall resort to borrowing

I disagree with the caveat regarding resorting to borrowings to fund expansion plans and continue to maintain a high dividend payout ratio though.

You can download the government's official circular by clicking here.

Dividend Policy Examples

Oil and Natural Gas Corporation (ONGC)'s Dividend Policy

ONGC is one of my favourite stocks. It is a member of our Portfolio 2K15 which I use as an example for teaching investing. I reproduce ONGC's dividend policy inside double quotes.

"Dividends are declared at the Annual General Meeting of the shareholders based on the recommendation by the Board. The Board may recommend dividends, at its discretion, to be paid to our members. The Board may also declare interim dividends. Generally, the factors that may be considered by the Board before making any recommendations for the dividend include, but are not limited to, future capital expenditure plans, profits earned during the financial year, cost of raising funds from alternate sources, cash flow position and applicable taxes including tax on dividend, subject to the Government guidelines described below:

As per the guideline dated February 11, 1998 from the Government of India, all profit-making PSUs which are essentially commercial enterprises should declare the higher of a minimum dividend of 20 percent on equity or a minimum dividend payout of 20 percent of post-tax profit. The minimum dividend pay-out in respect of enterprises in the oil, petroleum, chemical and other infrastructure sectors such as us should be 30 percent of post-tax profits."

Unfortunately, ONGC's website is referring to an old guideline of February 1998 instead of the latest one of January 2016.

Please see ONGC's actual dividend policy here.

Conclusion

What is dividend policy? The answer is it is the longterm view of a company management about rewarding shareholders with dividends from profits. It is important for investing. The investor should know the company's dividend policy before investing.

Dividend Payout Ratio

Dividend Payout Ratio – Meaning

Dividend Payout Ratio measures the proportion of the profits the company distributes to its shareholders as a dividend. The part that is held back is called retained earnings.

Dividend Payout Ratio – Formula

Dividend Payout Ratio – Example 

Rural Electrification Corporation Ltd. (REC)’ earned Rs.6,245.76 crores (1 crore = ten million) as profits after all expenses, including income tax. This sum is called the net profit or profit after tax or PAT earned by the company. REC distributes Rs.1,881.06 crores by way of dividends.

Applying the formula described above, we see that the dividend payout ratio works out to 30.12%.

Importance of Dividend and Dividend Payout

Dividends are the wages of the investors. Whatever may be the companies earnings the fruits or rewards that flow into the hands of investors is only the dividend. Therefore companies should distribute a sizeable portion of the profits to the shareholders in the form of dividends. However, most often we find that management of companies tend to be stingy when it comes to distribution of dividends. They justify the nonpayment or inadequate payment on the grounds that they are retaining the profits for business growth. This is stand is totally unfair and unjustified. For history shows that many companies that have not paid dividends one day became bankrupt. And what did the investors get in return? Nothing! Neither dividends while the company was doing well nor the return of the capital invested - for after becoming broke the shares became worthless.

Now, what is the proportion of profit distribution by way dividends that is considered good?

In my opinion and experience, 25% of the net profits is the bare minimum. 30% is reasonable and good. Anything above 30% is appreciable and welcome.

I present here five companies each that:

• Paid no dividends despite having profits, 
• Distributed between 25 to 30% of their net profits as dividends and 
• Those that distributed over 40% of their net profits in the form of dividends 

The above data relates to the last financial year, that is the year ending 31st March 2017.

Conclusion

Dividend payout ratio means the percentage of net profits of a company distributed by way of dividends among shareholders. As investors, we should invest only those companies that are generous in distributing dividends. The reason is that as investors dividends are the essential, regular returns on investments. We should penalise the companies that pay no or negligible dividends on the pretext of the growth of the company.

Related Reading

• Dividend-Definition

• Buy Top Dividend Stocks as Dividends are Investors Wages

• What Should Investors Do When A Cash Rich Company Refuses to Pay Handsome Dividends?

• 10 Best Dividend Paying Companies

• What is Dividend Yield?

• Debt Funded Dividends?

• What Is The Difference Between Dividend and Growth Fund. Which Is Better?

• All Investors Ever Wanted to Know About Dividends

• Dividends Rain Poem

Glorious Indian Stocks to Buy this August 2018

I present here the glorious Indian stocks to buy this August 2018. Only this morning I invested Rs.10,000 in these stocks. You can invest in them too.

All the 20 stocks both from the existing 'Portfolio 2K15' as well as the new finds were ordered into four grades “A” to “D” and “Rejected/ Not Analysed”. The classification is primarily based on the ROE. I tinkered with and redefined the rules of grouping. The status of the 20 stocks and their grading is depicted below:

The Rules of Grading

Glorious Indian stocks to buy this August 2018: Grade A

• Average ROE for the last 14 years is greater than or equal to 20% and
• The ROE for the year 2017 is greater than or equal to 5% but lesser than 8%

Grade B

• Average ROE for the last 14 years is greater than or equal to 15% and
• The ROE for the year 2017 is greater than or equal to 5%

Grade C

• Average ROE for the last 14 years is greater than or equal to 10% but less than 15% and
• The ROE for the year 2017 is greater than or equal to 10%

Grade D

• Average ROE for the last 14 years is less over 0%

Distribution of Investible Sum

The investible sum of Rs,10,000/- was distributed to the four groups as follows:

• Grade A: Rs.7,015/-
• The Grade B: Rs.1.343/-
• Grade C: Rs.1,194/-
• Grade D: Rs.448/-

You can see that ‘Grade A‘ commands the lion’s share of the sum of Rs.2000 – a whopping 70.15%. This is because of two reasons. The high ROE generated by the scrips of over 20% per annum, consistently for over 14 years. Further, there are seven stocks out of a total of 17 that have made it to this grade. Thus based on the number of scrips Grade A grabbed 41.18% (7*100/17).

Following table depicts the allocation based on grades, the number of scrips falling in the grades and the combined (multiplied, for in mathematics combined means a product and not an addition or sum):

Glorious Indian Stocks to Buy this August 2018: Norms Selection, Rejection and Distributing the Investible Sum

In my new scheme of things following are the measures for allocating the investment:

• 14 Year Average ROE %: 20% of the investible sum, Rs.2000
• The financial year 2017 ROE %: 20%, Rs.2000
• Price to Book Value Ratio (P2BV): 20%, Rs.2000
• Price to Earnings (PE) Ratio: 20%, Rs.2000
• Dividend Yield: 20%, Rs.2000

The combined  ‘Price to Earnings and Price to Book Value’ ratio is only used to determine whether a stock is expensive. I have not made any allocation of money under this norm. If a stock fails this test (PE*P2BV Ratio shall be less than 22.50), then the stock is expensive and is eliminated. No allocation of investment is made to the stock. For example, even though Hindustan Zinc and LIC Housing Finance had made it to Grade A, I have eliminated them. Their combined ratios stand at 49.67 and 32.10 respectively.

On the other hand, if a stock fails under any other criterion it simply will not get any allocation under that criterion. It will not be totally eliminated. For example, the Great Eastern Shipping Company Ltd.’s PE ration on 1st August 2018 was 28.42, more than the permissible 15. Its dividend yield on that day was 2.38%, below the minimum permissible 4%. Still, I did not totally eliminate it. Please observe the following table for selection/ rejection based on the combined ‘PE*P2BV Ratio’ criterion:

Glorious Indian Stocks to Buy this August 2018: Summary of Allocation and Number of Stocks to Buy

Finally, after allocating Rs.10,000/- as described above we get the summarised results as depicted in the following picture:

Allocation Based on 14 Year Average ROE

I present here the distribution of Rs.2,000 among various stocks based on the '14 Year Average ROE Criterion':

Allocation Based on Financial Year 2017 ROE

I show the distribution of the next Rs.2000 investment based on the ‘Financial Year 2017 ROE’ criterion in the following table:

Glorious Indian Stocks to Buy this August 2018: Allocation Based on Price to Book Value Ratio

I have worked the distribution of the next Rs.2000 based on the price to book value ratio as follows:

Allocation Based on Price to Earnings Ratio

Glorious Indian Stocks to Buy this August 2018: Allocation Based on Dividend Criterion

I present below the fifth and the last Rs.2000 of investment based on the dividend yield criterion.

Conclusion

These are the ‘Glorious Indian Stocks to Buy this August 2018‘. I have invested my Rs.10000 in the same stocks, exactly in the same proportion. You too can safely invest and benefit from the investment over a very long period of time. Happy investing!