The weaker side of generosity

High dividend payouts reflect low growth expectations

An analysis of India’s largest corporations — those comprising the BSE500 index — shows dividend payouts, which are profits repatriated to shareholders, have grown steadily over the past five financial years even as profit growth has faltered. The index covers every sector and includes public sector undertakings (PSUs), as well as overseas subsidiaries of Indian-owned private-sector businesses. So this indicates a broad trend.

In each of the last five financial years, these companies have paid at least 30 per cent of aggregate net profit as dividend. Aggregate dividend has grown from Rs 1.76 trillion in 2017-18 to Rs 3.02 trillion in 2021-22. Cumulatively, over the period concerned, 34 per cent of profit has been distributed as dividend. This is an extraordinarily high payout ratio, especially since India is classified as a high-growth emerging economy. America’s S&P 500, which includes the largest companies operating in the world’s largest and most mature economy, had a lower payout ratio of 30 per cent in the same period.

A trend of high dividend payouts has negative implications. The relationship between corporate profit, dividend, and retained profit indicates management expectations about growth prospects. High dividend payouts are associated with expectations of low growth.

Profits are the cheapest form of funding available. They can be used to pay down debt, reinvested to grow existing business lines, or used to create revenue streams. If instead, they are being handed back to shareholders, the implication is that the management believes it cannot re-invest in the business itself for higher returns. When this occurs across sectors, it suggests overall confidence in growth is low. What is more, this has been the case for the last five financial years.

There are complicating factors of course. Profit-making PSUs have always been encouraged to hand out large dividends to shore up government finances. They do this regardless of their growth prospects. Also, until recently, dividends were tax-free in the hands of recipients, which meant promoters preferred to use this tax-efficient route to reward themselves (and minority shareholders). But the amount of dividend payout has increased since the tax law was changed to make dividend liable to income tax. Also, it led to a spate of buyback offers since buybacks became more tax-efficient. Companies have also paid down debt, which is of course beneficial in that it reduces interest costs.

The broad logic remains valid. In an environment in which corporations see prospects of high growth, they will reinvest larger shares of profits to capture that growth in the cheapest way. Since India’s promoters have not done so, over an extended period and across a wide range of sectors, they don’t see high growth prospects.

This is paradoxical at first glance since corporate profits in this universe have grown from Rs 4.8 trillion in 2017-18 to more than Rs 10 trillion in 2021-22. But while profits have more than doubled, revenues have grown only 47 per cent. Profit margins have improved due to cost-cutting measures and lower interest rates. Companies did not need to expand capacity much from pre-pandemic levels. There is a limit to enhancing profit margins. The next stage of recovery must be driven by overall demand expansion, and by capacity expansion driven by rising demand.