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Analysis of Russian companies’ dividend policies

Author: Alex Freedmann Section: Business & Finance

Issue: October 2008, Vol.3, No. 9

Tags: Dividend policyIPORTSPayout ratio

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In developed Western countries, the level of dividend payments is one of the basic factors used by investors to choose companies’ stocks for investments. In the global market economy, shareholders traditionally receive their main incomes not from sale of stocks, as it was in Russia for a long time, but in form of dividends.

In 1999-2005, the increases in stock values significantly in Russia far exceeded the dividend yields. For instance, the annual increase in the value of the benchmark RTS Index over this period averaged 40%, while the average dividend yield of Russian companies’ stocks was about 2%. Consequently, shareholders of Russian companies’ stocks did not really care about the level of dividend payouts by those companies.

However, in 2006-08, the growth rate of the RTS Index slowed down significantly, and the shareholders started to pay more attention to the level of dividend yields. During the last two years, the dividend yield of Russian companies increased significantly and reached the level of dividend payouts in Western companies, which is about 3-3,5%, a trend which reflects the development of Russian companies and the general improvement of their financial state.

The payout ratio is another important parameter that characterizes the size of dividend yield, as it shows the percentage of a company’s net profit disbursed for dividend payments. For Western European companies, this ratio averages about 30-40%, while this ratio is about 50% of companies’ net profits in the United States. For comparison, a similar ratio for Russian companies averaged 10-15% in 2000-04, but rose significantly in the last four years to 20-25% of companies’ net profits.

Most generous and stingiest dividends-paying companies

In general, the size of dividend yields to certain degrees depends on the sector of economy, where a company operates. Thus, the most ‘generous’ Russian companies are in the oil, gas and metallurgical sectors, which are the most lucrative sectors of the Russian economy, while the ‘stingiest’ are companies from the power sector. The stinginess of latter case can be explained by the fact that electricity industry has in recent years been in need of capital investments and, consequently, companies in this sector could not afford to ‘pamper’ their shareholders with generous dividend payouts. At the same time, it needs to be noted that the dividend yields and policies can and do vary significantly from one company to another, even in one sector.

A review of the dividend policies in Russian companies has revealed one consistent pattern: the maximum dividends are usually paid in periods preceding the execution of IPOs and SPOs in most Russian companies. This is because an increase in dividend payouts always boosts shareholders and investors’ confidence in companies, but soon after the IPOs and SPOs, the size of the dividend payouts usually returns to the previous levels. A typical example could be seen in Magnitogorsk Iron and Steel Co. (MMK), which, prior to its IPO in 2006, spent almost 90% of its net profit on divided payouts, but quickly changed policy after the IPO, and thereafter, almost all the net profits were spent only on boosting production.

Trading strategies

One of the trading strategies on the stock exchange market is the purchase of shares of companies, which pay generous dividends prior to the record date. In this case, investors receive one more bonus, in addition to dividends: reduction of taxable base. According to the Russian legislation, an investor must pay a 13% income tax for revenues from the increase in the market value of stocks, but pay only a 9% income tax on dividends. Therefore, it is not surprising that the demand for shares usually increases significantly 2-4 days before the closure of the record date. It goes without say that companies paying generous dividends enjoy the highest demand.

However, there are not many ‘generous’ Russian companies, when it comes to dividend payouts. Traditionally, TNK-BP, GazpromNeft, Tatneft and Novorossiysk Commercial Sea Port Co. are among the few generous corporations. Similarly, North-West Telecom, Uralsvyazinform, Rostelecom, Surgutneftegaz and Tatneft are known for paying high dividends to holders of their preferred shares. However, for the majority of stocks on the Russian equity market, the level of profitability is low, and, given the high level of inflation, their dividend yields are, consequently, of low interest to most shareholders.

Conclusion

Western companies have dividend yields of about 3-3.5%, which is a serious reason for acquisition of shares in such companies. In the United States, a 3% profitability level is quite comparable to deposit profitability and bond rates, so the “buy-and-hold” strategy is quite comparable in terms of profitability to profits on the money market.

Presently, the Russian stock market is still in its infancy. Consequently, the dividend yields are notably behind the deposit profitability, which averages about 8-10%, though in terms of size, the dividend payouts level is quite close to their Western analogues. However, if in the near future, the fight against inflation becomes successful and the money market rates decline, then it is most likely that the majority of Russian investors will start paying much greater attention to the level of dividend payouts rather than the increases in the market values of their shares.