I have mentioned that one of my objective from my portfolio is to have dividend-based cash flow of Rs 500,000 by year end 2020. To show this feasibility, I could present a sophisticated excel based model with multiple different set of variables (i.e. make it complex). At a minimum, I know most of them would at least respect the effort. That’s how we are; we tend to appreciate complexity rather than simplicity. I like things to be simple. They are easy to understand and easy to implement. In this post, I am discussing a simple empirical exercise to demonstrate the feasibility of achieving my goal.

Before I demonstrate feasibility, following are few nuggets from Indian dividend landscape.

• There are more than 1400 Indian companies that pay dividends
• 2007-2008: Rs 52,150 crore is the estimated total dividends paid by Indian companies. This represents approximately 18.1% of estimated total net profits
• 2008-2009:  Rs 51,500 crore is the estimated total dividends paid by Indian companies. This represents approximately 18.7% of estimated total net profits

Now give this a little bit of thought. In almost all of the Indian companies, who have majority of the controlling stake. It is the promoters, owners, etc. Let us consider a conservative estimate that most of the Indian companies have at least 30% of promoter stake. With that, promoters/owners get Rs 15,300 crore of dividends (30% of Rs 51,000 crore). This is in addition of the value of the ownership. What do you think?

Let us move on to back-of-envelope calculation.

I have listed approximately 70 companies on my dividend paying companies web page. These are companies that I have read about. It is only a partial list. It does not include all the good dividend paying companies in India. Many good ones are missing. Within this list, the annual dividends per share range from Rs 0.80 to Rs 40. The average dividend for all 70 companies is Rs 8.9 (for 2009). The table below shows annual dividend per share and growth over last 10 years. Average dividend growth rate has been 9%.

As an investor, I have said many times on this blog, every dividend paying company is not a good investment. Let us assume that as of today, I want to invest in top 40 companies that pay me at a minimum Rs 5.00 dividend per share annually. I just pick a random set of 40 companies.

• with my end goal of Rs 500,000 I will have to buy 2500 shares for each company. [500,000 / (5*40)]. How much capital I would need to buy 2500 shares each in 40 companies ?
• total funds needed = [40 companies * 2500 shares each * Rs 644 average price] = Rs 6,44,00,000 i.e. Rs 6.44 crore. I have my Rs 500,000 cash flow with a capital of Rs 6.44 crore. I determine average price of all 70 companies as of April 21, 2010.
• this is less than 1% yield. Assuming I had Rs 6.44 crore, that would be a dumb investment. Why not just put into savings/FDs at 8%?

Please note; my objective to achieve Rs 500,000 cash flow is with minimum capital investment. Now let us do empirical optimization and see how we can minimize our capital investment.

Instead of looking at the list of 70 companies, let us narrow down to top 40 companies only. These top 40 companies pay at least Rs. 5.0 dividend per share.

• The average dividend per share is now Rs 14.2 (instead of Rs 8.9). You see quality matters. The table below shows the 10 year data for average dividend and growth rate.
• The average dividend growth rate is 12% (instead of 9%)
• The average per share price is Rs 774 (instead of Rs 644, you pay the price for quality).

So now we are focusing on quality companies only. In this case, the top 40 companies from my partial list which still not does include good dividend paying companies.

• number of shares needed per company = [500,000/(40*14)] = 892 shares per company
• total capital needed = [40 companies * 892 shares * Rs 774 average price] = Rs. 2,76,16,320. i.e. Rs. 2.76 crore
• This is again, approximately 1.8% yield.
• The point here is, by focusing of quality and sustainability I can achieve this with much lower capital of only Rs 2.76 crores. Earlier, the quality was not good, the dividends were lower, and hence I had to have larger capital base.

In this calculation, I still need to include dividend growth (positive effect), dividend reinvestment (positive effect), and share price appreciation (perhaps negative effect). Now, let us include this into our calculation.

Consider that at begin of 2010; I buy 50 shares of one company in my portfolio. Each share price is Rs. 774. Each share has an average annual dividend of Rs 14. Therefore, the total investment in one company is Rs 38,700 only.

• I will consider dividend growth rate of 12% every year;
• dividends are reinvested only once at the end of each year; and
• at the end of each year, I will appreciate the price of stock by 12%. The reason for using 12% is I expect minimum of 12% return in my portfolio.

Let us do the math:

• at end of 2010, total dividend received Rs 700; price of share Rs 867
• beginning 2011, number of shares [(700/867)+50] = 50.81
• end of 2011, total dividend received Rs 797; price of stock Rs 971
• continuing this until end of 2020, number of shares is 58.69, total annual dividend is Rs 2552.
• my initial investment of Rs 38,700, gives me dividend cash flow of Rs. 2552
• Plus, there is also an increase in capital appreciation.

Consider that instead of investing in just one company, I would have invested in all 40 companies today itself.

• total invested capital [40 companies * 50 shares * Rs 774 average share price] = Rs 15,48,000
• total 2020 dividend cash flow = [Rs 2552 * 40] = Rs 1,02,080
• what this is telling me is, Rs 15.5 lakh invested in good dividend paying companies, will give me Rs. 1.02 lakh dividend cash flow.
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Another way to look at this is; to get Rs 5.00 lakh dividend in year 2020, I need [15.5 * 5] = Rs 77.5 lakh capital investment as of today.

To summarize….

As of today, if I invested Rs 77.5 lakh in 40 companies from my existing incomplete list of dividend paying companies, then I should be able to reach our 2020 goal. This assumes dividend growth of 12%, annual dividend reinvestment, and share price appreciation of 12%.

When we just look into present day yields, my first calculation showed I needed Rs 6.44 crore. With certain generic assumptions, and focusing on good quality and sustainable dividends, the capital requirement came down to Rs. 77 lakh. The only question is; are these assumptions valid or feasible. To me, the assumptions I have made are feasible and executable. They are not theoretical assumptions. Plus, at this point, I am not even discussing capital appreciation.

Furthermore, it is my belief that I could further reduce this original capital by making sure that I buy shares at good price and not when they are high. The average price that I have used (Rs 644 or Rs 774) is 2010 prices which I believe are too high to be buying.

The purpose in this empirical calculation is to show that my objective is feasible. Keeping things simple is the best strategy. Simply buying good companies with sustainable business models, good quality dividends, and reinvestment dividends, will help you increase your overall wealth. Buffett also receives significant chunk of dividends in BRK portfolio.

This post also helps answer many questions I have received over last few months on this topic. Any questions, or thoughts, leave your comments below.

The article was published in Money Hack Carnival # 116, Back to Basic Edition.

dividend cash flow, invesment objective, investment goal, money hack carnival, portfolio management