Any ordinary investor would be jumping with joy for the unexpected interim dividends that companies are declaring. Interim dividends of 100-150% have become common these days. Big or small, brands or commodities all the companies are declaring fabulous dividends. Novartis declared 150%, Bajaj Auto declared 100%, HDFC announced 90%, Sun Pharmaceuticals gave 40%, Archies Greetings paid 26%, MTNL made it 20% and the list could go on. More than 50 companies have already declared interim dividend and many more are expected to follow. It is estimated that the companies save an amount of Rs.250 Crores by paying interim dividend before June. How they are going to save this amount is interesting, but the implications of this interim dividend phenomenon are worth noting.

The puzzled investor is wondering what has made these companies so generous. The answer lies in the hike in dividend tax in the Budget-2000 from 11% to a whopping 22%. As per the new provision of Section 115-O of the Income Tax Act, dividend declared, distributed or paid on or after June 1, 2000 would attract 22% dividend tax. By declaring dividends before that date the companies will be saving a whopping 11% as tax payable on dividends.

Not surprising then that companies and the investors are smiling all the way to the bank But the biggest beneficiary of the entire exercise has been the equity markets. In the aftermath of the market-unfriendly budget the sensex went into a tailspin. But the generous interim dividends paid by the companies has been welcomed by the shareholders and the market downslide, which could have been much worse, has been arrested. The hope is that by June when the new dividend tax rates come into force the markets would have begun reacting positively to the good corporate results that are likely to flow in.

Let us look at this phenomenon from a valuation perspective. Value of any stock and consequently the market depends to a large extent on the rate of return expected by the shareholders. More specifically the determining factor for valuations is the difference or the hiatus between the expected rate of return and the actual return. The imposition of dividend tax had widened this gap and consequently the markets went into a tailspin. The high returns as a result of generous interim dividends has been instrumental in arresting the fall in the markets by narrowing the gap between expectations and reality. Else it is anybody’s guess where the markets would have ended. Thank the innovative Indian companies for small mercies!