Is Dividend Reinvestment A Good Idea In India?

Hello All,

Hope everyone is having a great day.

I did not find a thread on Dividend Reinvesting in India for long term and so decided to create one. Moderators kindly delete this thread if there is one already.

I have completed a few books about Investing viz. The Intelligent Investor, Stocks for the Long Run, One Up On Wall Street, The Future for investors by Jeremy Siegel etc.

All of these stocks especially The Future for investors by Jeremy Siegel recommend strongly dividend reinvestment and investing in stocks which pay dividends.

I have noted that Benjamin Graham in his book The Intelligent Investor does point out that one must not invest in stocks only for dividends and I also agree that Peter Lynch leans more towards growth stocks. Noteable is also the company Berkshire Hathway which does not pay dividends, but they do seem to be invested in companies which pay dividend. But I did watch a video where Charlie Munger and Warren Buffet speak quite positively about tobacco stocks when asked about it. They say tobacco stocks which pay a good dividend are a good investment. In one more video they state that they did have the opportunity to invest in some good tobacco stock, but they decided to draw a line for ethical reasons.

The Future of investors by Jeremy Siegel emphasises very strongly on investing in companies which pay dividends. He goes as far as to say that dividend paying stocks must be preferred over high PE growth stocks because the dividend is constant and allows an investor to buy more and more of that stock compared to a highly valued growth stock.

In my mind there is no doubt that for the long term investing scenario and to create wealth over a long term buying good dividend paying companies and then reinvesting the dividends to buy more of the stock is one of the best and sustainable ways.

But what keeps nagging me is that none of these books consider the scenario in India. Here we do not have the option of Dividend Reinvestment Plan(DRIP). An investor has to pay tax on the dividends received and then buy stocks through the broker. This results in some significant/not so significant charges over the long term depending on the tax and the brokerage situations.

But on the average the investor will incur the following charges:

  1. Tax on the dividend
  2. Brokerage
  3. Tax/Stamp Duty on the stock purchases when reinvesting.

Due to this it would be really helpful for me and I am sure for a lot of others if seniors and experienced members or anyone can comment and advise on this. Is dividend reinvesting a good idea in India for long term (over 15 years) wealth creation ? Or do the transaction costs outweigh the returns?

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Dividend reinvesting is investing the dividends received from the shares you hold. Not sure if you mean re-investing in the same stock or elsewhere. Irrespective, this question boils down to whether you should invest any savings surplus (including dividends) into equity. If you are an investor then you have already answered the question.

DRIP is a facility provided by companies (not in India), which gives you an option to re-invest the dividends into its own stock by buying them with the dividend money you would otherwise have received. This is not provided by Indian firms largely (I guess) because the efforts outweigh the benefits because there is not much demand for it.

As such most investors here do not expect dividends and companies do not want to give it. Our tax structure and the way it has evolved have shaped these expectations. Long Term Capital Gains (LTCG) was zero and as was dividend some decades ago. Over time dividends have come to get taxed more and more till it reached marginal rate. LTCG on the other hand has seen only one raise to 10%++ from 0. So companies have reduced the payout ratio (amount of profits given out as dividends), retaining more of their profits - which in a sense is reinvestment of dividends but without the tax related transaction costs.

If shareholders wanted the cash equivalent of dividend, then they can sell that portion of the stock with a tax incidence of just 10% vs say 30% (which I guess would be for a median retail investor).

This also goes with the narrative that firms need money (‘growth capital’ :slight_smile: ) because they are growing rapidly. So it serves Promoters to keep more cash within the firm.

Consequently DRIP does not make sense here for companies and there is not much demand for it.

It’s interesting to point out though that many firms that don’t need capital and controlled by Promoters who need that capital, continue to have high payouts. HUL / TCS for example (MNCs largely). Quirkily HUL parent (unilever PLC) does not have to pay taxes on the dividend it receives because it is not an Indian resident; and it’s dividend in India is not subject to tax in the UK. So for other MNCs that structure their holding it for tax purposes. TCS paysout because Tata Sons needs it (in my assessment for paying interest on its borrowings). Consequently other shareholders, especially Resident Indians have to receive these tax heavy dividends even if they did not want to :grinning_face_with_smiling_eyes:

I may be digressing but in my view this tax on dividend and the tax distortion has an impact on capital allocation by firms - I wrote about it here, in case you are still not bored! It will surely lower long term ROE.

DRIP will make sense for the company and an investor when dividend yield is > bond yields, the company does not need the money it made and there is little tax incidence in giving dividends. The current environment is not such.

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Unless one’s salary cap is non-taxable , it doesn’t really make sense in India. I personally use it as an alternative form of FD’s as interest rates are too low and those companies aim to keep increasing dividends in future in addition to being available at good dividend yields. Since I am equity(growth) heavy, it makes up only a small portion of my portfolio.

The Future of investors by Jeremy Siegel emphasises very strongly on investing in companies which pay dividends. He goes as far as to say that dividend paying stocks must be preferred over high PE growth stocks because the dividend is constant and allows an investor to buy more and more of that stock compared to a highly valued growth stock.

I wouldn’t want to reinvest dividends in a dividend paying company that is overvalued. I’d rather reinvest dividends in undervalued stocks rather than an overvalued stock. Also, please lookup dividend irrelevance theory.