As the growth trajectory of the Indian economy becomes increasingly well-established, equity investors are naturally anticipating strong returns in the mid to long term. However, while growth remains a crucial driver of wealth creation, dividends also play a significant role in enhancing investor returns.

Dividends, which represent the portion of a company’s profit distributed to shareholders annually, are an important aspect of total returns. For instance, the Nifty 500 index has demonstrated a compounded growth rate of 12.5% from January 2000 to July 2024. In contrast, the Nifty 500 Total Return Index (TRI), which incorporates dividend payments, has grown at a compounded rate of 14.2% over the same period. This indicates that dividends have contributed an additional 1.7% to the overall return.

While a 1.7% increase might not seem significant at first glance, its impact over 24 years is substantial. If an investor had put ₹1 lakh into the Nifty 500 TRI in January 2000, its value would have grown to ₹26 lakh by now. In comparison, an investment of ₹1 lakh in the Nifty 500 index, excluding dividends, would have appreciated to ₹18 lakh. Thus, dividends alone have accounted for more than 30% of the total returns over the past 24 years.

Dividends are a crucial indicator of a company’s financial health and ability to generate consistent profits. As the adage goes, “Turnover is vanity, profit is wisdom, and cash is reality”—dividend payments are a key sign of a company’s cash richness and profit consistency. Companies need capital for growth and expansion, and while fresh equity and debt are options, generating consistent free cash flow is vital. Regular dividend payments reflect a company’s capability to generate steady cash flow and support its growth.

Moreover, companies that pay consistent dividends tend to have stocks with lower volatility compared to the overall market. This stability is due to the attractiveness of dividend yields, which can help form a natural price floor. Research indicates that the beta of the Nifty Dividend Opportunity 50 TRI, compared to the Nifty 50 Index, is 0.82 over the last five years, suggesting lower volatility.

There is a common misconception that companies with lower volatility and better dividend yields offer lower returns and growth. However, this is not necessarily the case. Investors do not have to choose between growth and dividends; rather, they can benefit from both. Dividend-paying companies often provide strong returns through both stock price appreciation and consistent dividend payouts.

Furthermore, dividends are not exclusive to large companies or those with low capital intensity. Companies across various market caps and sectors, including mid-cap and small-cap companies and even capital-intensive industries, pay dividends.

In summary, dividends are a key component of total returns, particularly when compounded over long periods. They serve as a strong indicator of a company’s ability to generate free cash flow and are often associated with consistent growth. Thus, investors should recognize the importance of dividends alongside growth in their equity investment strategies.

This story is attributed to Shiv Chanani, Senior Manager, Equity, Baroda BNP Paribas Mutual Fund