Is Dividend Reinvestment A Good Idea In India?

[vishwa.bhat19]

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?

[diffsoft]

@vishwa.bhat19

Is dividend reinvesting a good idea in India for long term (over 15 years) wealth creation ?

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’ ) 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

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.

[vibhor_vaish]

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.

[newbie_007]

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.

[Ghonarbochon]

I am trying this out with PFC REC and ITC myself . I think it should work fine if the time horizon is long.
The ITC experiment started almost 2 years ago … and I already have 60 stocks bought from dividends while I have 480 or so originals even though paying 7.5% tax on the dividend(I pay rest of the tax out of my pocket anyway but buy the stocks from the money credited to my account).

[ChaitanyaC]

@Ghonarbochon

while I have 480 or so originals

What is this 480? I couldn’t understand.

[Ghonarbochon]

I mean that I had bought around 480 or so stocks of ITC and in past 2 years I have added 60 more out of the dividends I received.

[Sudhakar_Subramanian]

Is there any tax concession on the dividend recieved if it is reinvested? Currently the dividend is taxed at peak slab in the hands of the individual receiving it.

[Rax]

In principle, most of the self-proclaimed educated/informed investors (including myself) will always gun their strategy for growth investing which is true in scenarios when looking at long-term wealth creation given the historical data.
However, there comes a time when you feel, the ROI and realized gain so to say aren’t what you would have expected. Additionally, given the current turmoil scenario in the markets, most of the new pandemic stock market investors would have realized what in reality the stock market is.

Another aspect is the mental churn with the current information age wherein data is available in abundance and keeping up real-time/daily/weekly/monthly with everything happening in and around the companies you are invested in along with macroeconomic and global scenarios in really taxing.

To the point that I am trying to bring the attention that after several years of investment eg. in a decade not everyone would want to continue to be into money making machine scenario and take things a little slower and let the system do its thing. Also, this narrative fits very well in the current bear market and global slowdown scenario.

Considering the below scenarios of Power Finance Corporation (PFC) and looking at its monthly chart, please see the performance:-

If we were to remain invested and continue to accumulate at lower range, the stock has given 100% return every 2 years and a superb dividend yield.

Given the goal of this company is to continue doing business as usual and pay heafty dividends back to govt kitty and not look at growth can really work out even for retail investors in long run.
It is a Maharatna company backed by GOI with a crazy pile of debt of 660K CR but they seldom aim at reducing the debt but prioritize high dividend payback as this money is used by ‘govt in power’ to invest/showcase in the growth story of India.

Last checked for FY21, with stock price hovering between 100-150, the total dividend paid up was 12.75/share which is a very good yield in current FD and bear market scenario.

There should not be any harm in diversifying your portfolio into a dividend strategy from Year1 and slowly increasing that % eventually making it 50%+ as your energy level and enthusiasm subsides in the journey of life.

You also need not break your head on daily basis crunching numbers etc. along with some sweet upside as icing on the cake. At last, we all want to chill and take things slow and not everyone wants to be mentally involved our whole life in the stock market like warren buffet but do enjoy other things like following our passion, travel, explore, family time and sleep in peace.

[sivaram]

This has happened to me more by accident than by design. My overall div yield across stocks has crossed 4.5% because as a newb in 2004 all my stock picks were negative price wise from where I bought. Left it alone for a decade as I couldnt bear the loss sale.

Now?

NALCO which I picked from 28 to 38, gives me 12% yield or higher. Mostly PSU stocks have paid off handsomely. Powergrid yield is now 25%. I rarely sell nowadays as even with the fall I still am in the green and even with reduced dividend, it’s still more than market FDs on lots of my shares.

[Sudhakar_Subramanian]

Since last 2 or 3 years dividends are taxed at peak rate in the hands of the investor. If your taxable income is above 15 lakhs, 30% is the tax. If it is above 50 lakhs, 34% inc surcharge and cess.

This applies to savings account, FD interests too. But post tax, dividends don’t look very lucrative compared to capital appreciation in stock price, where even STCG is just 15% flat.

[Ghonarbochon]

Dividend reinvestment is not supposed to be exiting .Its a FD replacement that gathers steam as it goes .Capital appreciation is dependent on market whims .Market may not reward good business performance fo very long but dividend will increase if company consistent payout policy and performs. See the REC PE chart …

Consider the case of ITC and HUL between 2002 to 2022 . If you bought ITC for capital appreciation in 2012 seeing its price action for past 10 years you would have got no returns till end of 2021.But the dividend has continued to increase.
Dividend investment policy is for long term . As mentioned in the post by @sivaram ,see what happens over long term .

[Sudhakar_Subramanian]

Dividends may work well for some but not for me. I’d rather invest in companies that return cash in the form of buyback which doesn’t attract this much tax.

For Companies that pay hefty dividends, the stock price falls more than the dividend amount on the day after ex record date.

Disc:
Paid a lot of taxes for dividends received from Vedanta. Will be gifting those shares to my wife who doesn’t have any income.

[gsapte]

I believe that, for those investors (mostly working or salaried people) who do not need or do not depend on Dividend income for their regular expenses, it might be good to focus on Growth stocks which invest the profits back in the business and distribute less dividends.Dividends are not tax efficient as of today.

Dividend re-investment in the same stock has its pros and cons:
Pros:
(1) You will keep buying the stock using post tax dividend income, thus increasing no. of shares in the long term. This is useful if you want to hold that stock for more than 8-10 years.
(2) You may not have to track where the dividends are getting consumed since you will re-invest it.

Cons:
(1) You may end up averaging up, since you might buy more shares at higher prices. If your investment in that stock is only for 3-5 years, this may not be good.

So, it may vary from an investor to investor whether dividend should be re-invested or used for some other recurring goals like yearly vacations, insurance premiums, buying gadgets.

For those which are partially retired, Dividends certainly give additional income for regular expenses or can be used for recurring goals.

[sivaram]

Before the div taxation policy came into force, the div income was significant for me. And I put it out that, one does not have infinite amount of cash to buy the dip, timing, technical trading etc. At any given point, my stock notional gains are just that, notional. However, a dividend is credited to my account which I use to buy stocks even in low quantities.

I suspect, most are put off by the low dividend amount initially as it was for me, 10 years back. Now, coal India/HZinc cutting a div of 3K to 4K as interim makes it a thoughtless buy of 2 shares of HDFC or Reliance.

[Sudhakar_Subramanian]

@sivaram

Before the div taxation policy came into force,

In 2013, I was holding strides arcolab at 350/share. And got 500/share as special dividend. Company paid 10% dividend distribution tax. Those were good times. Now if I get it, I’ll be paying 170/share as income tax.

Strides Arcolab declares special dividend of Rs 500 per share, stock closes...