Dividend: the unsung hero

During bearish times when the Sensex plumbs new depths and the entire market looks like a discount sale, it is natural to doubt the basic assumption that investing in equities really pays off. We have come across stories with bold headings carried by newspapers and magazines:

Equities do not fetch good returns in the long run If you had invested in 100 shares of Tisco in the beginning of 1991 at Rs110 per share, you would have realised only Rs130 per share after ten years?.

We are not here to make a case for investing in equities for the long haul. We are here to just spare one moment to look at stories like these to see if it is all too simplistic or if we have missed out something.

Imagine we actually bought 100 shares of Tisco in 1991 and held on to it till 2001. Would we have received anything for holding these shares during this period? Of course, yes! We would have received dividends every time the company's board declared one.

How much would we have received in case of Tisco during this period?
We just checked the company's dividend payout record during this period and figured out that we would have received Rs25 in all for every share held. True that according to the study, from one particular day in 1991 to another day in 2001, (on a point-to-point basis) Tisco could have appreciated by just Rs20. However, any investor holding on to the stock during the period would have realised another Rs25 in the form of dividends. Hmm! More money from stock dividends than from appreciation in stock prices.

Dividends did make a significant difference
Of course we could debate whether it still made returns better et al. There are arguments and counter arguments. After all, one needs to stay invested in good businesses at right prices. Tisco hit a high of Rs300 plus in 1995, that was 300% in four years. But we are not here to prove a point.

We are here to recognise an unsung hero--Dividend!
Dividend is any payment made out of the profits of a company and approved by its board of directors. Most stable companies have a higher dividend payout whereas many growth companies retain profits to sustain their growth rates. However, in no way are dividends insignificant.

Remember "power of compounding" ? It transforms the seemingly insignificant dividend inflows into a very significant inflow. Here is a simple illustration.

For a moment, allow us to indulge in an exercise similar to the Tisco example above, a mere point-to-point comparison of the price of the HLL stock over a period of seven years, from end-1993 to end-2000, to understand our unsung hero better. J

An investment of Rs1,000 in HLL at the end of 1993 would have been worth Rs3,570 at the beginning of 2001, ie a 20% per annum compounded rate of return over a period of seven years.

Comparison of returns on HLL investment between end-1993 and end-2000

Period	CMP of HLL	Investment	Org#Sh	DPS	Dividend Reinvested	Addln Sh	Tot #Sh	With Div	W/O Div?
Dec - 1993	58	1,000	17	2.27	0	0	17	-	-
Dec - 1994	59	-	17	3.48	39	1	18	-	-
Dec - 1995	63	-	17	4.40	0	1	19	-	-
Dec - 1996	81	-	17	10.24	0	1	20	-	-
Dec - 1997	138	-	17	13.92	0	1	21	-	-
Dec - 1998	166	-	17	19.86	0	2	23	-	-
Dec - 1999	225	-	17	29.01	0	2	25	-	-
Dec - 2000	210	-	17	35	0	3	28	5,948	3570
-	-	-	-	-	-	-	CAGR	29.01%	19.94%

Note: CMP = current market price; Org # Sh = no of HLL shares Rs1,000 could buy in December 1993; DPS= dividend per share; Addln Sh = more shares of HLL bought with the dividend payout every year; Tot # Sh = Org # Sh + Addln Sh--the total outstanding investment in HLL; With Div = money/ returns made by reinvesting dividends; W/O Div = money/returns made without dividend reinvestment.

To add a twist to the tale enter our unsung hero?
Let us assume that we reinvest the entire dividend that we get every year on our HLL holding to buy shares of HLL again. So in our case, the 1993 dividend payout would help us buy one more share of HLL. The 1994 dividend would help us buy another share of HLL and so on. Any guess on how much extra we would make?

How does a mere 50% improvement in returns sound?

Yes, 50%! Our investment of Rs1,000 at the end of 1993 would be worth Rs5,948 at the beginning of 2001, ie a 29% per annum compounded rate of return over a period of seven years! Almost double the money we would have made on our investment if we'd realised only the appreciation in the stock price.

If we borrow our learning from "Power of Compounding" and stretch the horizon, then the heroic act of "dividend" hits us really in the eye.

In a very simple manner, Rs1,000 turns into Rs95,000 (95 times) if HLL price continues to compound at 20% per annum for 25 years. On the other hand, Rs1,000 transforms into Rs6,00,000 (600 times) if the rate of return improves to 29% because of dividend reinvestment over a period of 25 years.

If our investment horizon is 25 years and we decide to make the seemingly paltry dividends that we earn work for us by reinvesting them, we might actually make six times more than what we would if we didn't reinvest the dividend every year.

Did we read somewhere that tiny drops of water make a vast ocean?
In the long run, investments in stocks are attractive as much for the dividends they pay out as much as for the appreciation in their prices. It is no coincidence that in both the cases (Tisco and HLL) we saw the returns double when reinvestment of dividend was taken into account. So the next time your company declares a dividend, you know exactly what to do?