Do Dividends Affect Stock Returns?

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 analysis, the focus was exclusively on companies that were listed on the stock exchange before FY2010. The first step was gathering their dividend payout history between FY2010 and FY2022. This ensured that a substantial time frame is captured, accounting for the financial cycles and fluctuations experienced by these companies. All dividends per share paid during a financial year, including interim and final dividends, were included in this analysis.

Consistency of dividends and stock returns

First, let's understand how the consistency of dividend payouts affects stock price returns.
Since the period between 2010 and 2022 was a 13-year period, companies were categorised into four based on their dividend-paying consistency. The four categories were:

• Companies that have not paid dividends at all since 2010
• Companies that have paid dividends irregularly (6 years or less)
• Companies that have paid dividends in most years (7 years or more)
• Companies that have paid dividends every year since 2010

Stock prices as on Jan 1, 2010, and Apr 29, 2023, were used to calculate CAGR return for each stock. The median return for each group of companies was then calculated.

Here's a table to summarise the results.

*Stock price returns reflect the price adjustments due to various corporate actions, such as stock splits, dividends, and mergers during the period of study.

Companies paying consistent dividends can potentially outperform their inconsistent counterparts

Companies that never paid dividends reported a median return of 1.4%. Interestingly, even not paying dividends fared better than irregular dividend payments since companies that paid dividends six times or fewer in a span of 13 years achieved a mere median return of 0.4%. This emphasises 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 same 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 strongly indicate that companies that consistently pay dividends have the potential to outperform companies that don't pay consistent dividends.

Growth of dividends and stock returns

Next, the impact of increasing dividends per share on stock returns was studied. All dividend-paying companies are classified into 4 groups based on their dividend growth streak.

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 four categories based on dividend growth streak were:

• Companies that have never increased their dividend per share in any consecutive year i.e. dividend growth streak of zero.
• Companies that have increased their dividend per share year-on-year in 6 years or less i.e. dividend growth streak between 1 to 6.
• Companies that have increased their dividend per share year-on-year in 7 years or more i.e. dividend growth streak between 7 to 12.

Companies that have increased their dividend per share every year (13 years) i.e. dividend growth streak of 13.
Then, the median stock price return of companies in each of the above categories was calculated. The results were striking, to say the least.

*Stock price returns reflect the price adjustments due to various corporate actions, such as stock splits, dividends, and mergers during the period of study.

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

Companies with constant growth in dividends per share achieved the highest median return of 22.98%. This category consisted of only six companies namely Reliance Industries Ltd., Berger Paints India Ltd., Pidilite Industries Ltd., ITC Ltd., Asian Paints Ltd, and Sundaram Finance Ltd. Their exceptional stock performance underscores the significance of consistent dividend growth.

In contrast, the 275 companies that failed to increase dividends year-on-year reported a meagre return of 0.41%.

Which sectors have the most generous dividend payouts?

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

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.

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.

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.

The views and opinions stated in the content belong to Naveen KR, smallcase manager, Senior Director - Investment Products, Windmill Capital.