Sometimes large-scale companies with predictable profit pattern reward their shareholders by sharing a part of the earnings with them. This mode of sharing of profit is known as ‘dividends’, and they are usually paid in cash or as additional stocks of the company. There is a prevalent trend in most firms of utilising the major portion of the ‘net profit’ for infrastructural development and accomplishing future projects. However, companies allocate a certain percentage of the remaining profit to shareholders to maintain and grow their trust.
The board of directors of the firms decide and manage the value of dividends paid to investors. Shareholders get awarded with these added benefits if they own stocks by the ex-dividend date. It gets disbursed monthly, quarterly, or annually. Sometimes, companies also release non-recurring special dividends (individually or in addition to the regular dividends) if they register strong business performance.
Along with public-listed companies, multiple mutual funds, and exchange-traded funds (ETF) also, award dividends to investors. So, by now, you have obtained an outlined idea about the dividend’s meaning. However, if you wish to attain in-depth knowledge on this domain, then go through our specially curated tutorial on dividends.
How are dividends paid to investors?
Dividends earned by investors depends on the total number of shares they own. For instance, if a company declares Rs 200 dividend per share, and you hold 500 stocks, then you can earn Rs 10000 through dividend payments.
In general, real estate, utilities (electric power, oil and natural gas), banks, healthcare, and pharmaceutical companies regularly award dividends to shareholders. However, technological, and biotech companies, despite registering high growth refrain from releasing dividends. They tend to utilise most of the profit in future expansion strategies to continue their exponential growth.
In some cases, companies may also decide to offer a property dividend (any item with tangible value) instead of cash or stock to investors. These dividends get recorded at the stock exchange according to their valuation on the declaration date.
What are the important dates of dividends for stock investors?
Every company follow a set of protocols for reporting and paying dividends to investors. There are a few important dates of the dividend which investors need to remember.
Date of Declaration:
The date of declaration is the event when a firm announces the quarterly dividend and the subsequent payment dates. For instance, a company may decide to award a quarterly dividend of Rs 50 per share on 10th July to stock owners of record as of 30th August. So, in this case, the date of declaration is the time of announcement of dividends.
It hardly matters whether investors purchase the share before or after the date of the declaration. The date of record, on the contrary, decides whether you can avail the stock’s quarterly dividend.
Date of Execution
The date of execution is the timeframe when investors initiate the share transaction. They place an order either for buying or selling a share on the date of execution. For instance, if you have a word with your broker regarding the purchase of shares on 15th January, and own the same on 18th January. Then, 15th January is the date of execution as you initiated the transaction on that date.
Closing Date
The closing date is also known as the settlement date. On this day, investors finalise the share transaction and close the deal. It usually occurs after three business days of the date of execution.
The concept of the closing date in share transaction is similar to all other business dealings, where you become the proud owner of an ‘asset’ (in this case share). If we take the previous example, where the investor’s date of execution was 15th January, and the closing day of the deal was 18th January. Then, the closing day, in this case, will be 18th January.
Ex-Dividend Date
The term Ex-dividend signifies without a dividend for shareholders. It is the three-day period during which even if you initiate the transaction of a stock buying; you do not become the official owner of the same. Companies allocate the three-business-day period for the processing of shares. During this timeframe, investors do not remain on the books of record as the closing date of shares falls after their date of recording.
However, there is a silver lining. During, the ex-dividend dates, stocks trade at a lower than usual price. So, even if you do not receive the dividend, the stock becomes your asset for the future at a lower asking price.
Date of Record
The date of record helps in identifying shareholders who would get awarded with dividends after the board of directors make a declaration. Since traders transact in stocks regularly on the exchange, it is essential to establish a cut-off date. The firms use the date of record for this purpose. If you are an official shareholder on the date of record, then you would get benefitted with the dividend on the payment date. It remains true even if you decide to sell the shares between the date of declaration and the date of record.
Payment Date
The payment date is the day on which firms issue their dividend checks to shareholders.
Here, it is worth pointing out that there is a three-business-day gap between the ex-dividend date and date of record. Similarly, another three-business-day difference exists between the date of execution and closing day. These pieces of information would help you to analyse whether you can qualify for upcoming dividends. You can also purchase stocks according to these timings to attain maximum benefits.
What are the different types of dividend?
Now that we have formed an outline idea concerning the dividend’s meaning and the important dates related to it, let us study the various types of the dividend.
Cash Dividend
It is one of the most prevalent modes of dividend pay-out. Here the board of directors promises to award dividends as cash rewards to existing shareholders on the date of declaration.
Stock Dividend
In this case, the company decides to issue stock to committed shareholders. If the newly released stock accounts to less than 25 per cent of previously outstanding shares, then we call it stock dividend according to finance terminologies. On the contrary, if the current transaction of dividends surpasses the already outstanding shares, then companies treat it as a stock split. You must remember that, whenever companies issue stock dividends, they transfer an amount equal to the fair value of stock dividends from retained earnings to capital stocks.
Property Dividend
Sometimes companies also disburse a non-monetary dividend to investors. The value of property dividends gets marked according to fair market prices of these assets. However, sometimes, the market value of the stock dividend may not be equal to the book value of the assets. So, companies record the parity in the market value as a corresponding loss or gain. Often, firms deliberately release the property dividend to manipulate taxable or net incomes.
Scrip Dividend
If the company do not have enough assets to release dividends shortly, they may disburse a scrip dividend to gain the trust of shareholders. The dividend decision acts as a form of assurance note of their willingness to paying funds to stock owners in future.
Liquidating Dividend
If companies decide to return their shareholders the total price of shares owned by them as dividends, then it is known as the liquidating dividend. In most cases, companies disburse these bonuses before dissolving. The funds for liquidating dividend get released from the additional paid-in capital and the accounting process is similar to the documentation of cash dividends.
Interim Dividend
Companies release a special type of dividend before officially declaring their financial statements and hosting the AGM (annual general meeting). This unique dividend scheme is known as the interim dividend, and it mostly gets released along with interim financial statements. Companies awarding semi-annual dividends usually release this type of bonuses. Though final dividends get paid from current earnings, interim dividends come from retained earnings. The financial statements remain unaudited during the disbursal of interim dividends.
The value of the interim dividend is usually less than the final dividend. Though the board of directors declare this dividend, the approval of the same depends on the discretion of shareholders. Similar to all other forms of dividends, the interim bonus can be either in the form of stock or cash.
Dividend Rate vs Dividend Yield
We already know that a dividend rate is a total income per stock of a company in a fiscal year. Investors also hear about another term- dividend yield while dealing with shares. Let us have a comprehensive view of both these terms.
Dividend Rate
Dividend rate helps you to calculate the total earnings from shares, mutual funds, or other portfolios in a financial year. You can obtain this value by simply adding up all the quarterly or semi-annual dividend payments. Companies issue their dividend rate on an annual basis. However, they may not consider additional bonuses (non-recurring dividends) while calculating the figure. It can either be fixed for a firm or revised periodically.
Let us take an example; a company pays an annual dividend of Rs 2000 per share in four quarterly payments. So, in this case, you would receive Rs 500 per quarter as a dividend payment.
Dividend Yield
Investors can also use dividend yield for determining the total income from stocks. It is different from the rate, as it gets quoted as a percentage (and not as a currency figure). The yield helps in comparing the size of dividends among various groups of shares.
You can calculate the yield by obtaining the ratio of the annual dividend to its current stock price. So, even if the dividend remains the same, the financial year in which the share price is low, the yield will look higher. Similarly, when the stock price increases, the yield seems lower as they are inversely proportional to each other.
Dividend Yield= Annual Dividend/Stocks Price
So if the current price of the stock is Rs 200, and the annual dividend paid to each investor is Rs 50.
In this case, the Dividend Yield= Rs 50/Rs 200 = 0.25
As the dividend yield varies considerably from year to year, it has minimal significance in determining the future rate of return (ROR) of stocks. However, investors tend to give more emphasis on the yield than the rate while selecting favourable shares. It is because firms offering better dividend yield are paying more returns to stock owners’ investments. So, we can say that it is better to receive Rs 20 as dividend from a Rs 100 value share, than gaining Rs 50 from a Rs 400 share.
What is a dividend payout ratio?
The dividend payout ratio is the percentage of the net income of the company that they award as dividends. Investors can calculate it by obtaining the ratio of the total amount disbursed as dividends to the net income of the firm. Similarly, there is also a retention ratio based on the percentage of net profit. It is the amount which the board of directors decide to retain in the concern. It helps in projecting the future growth of the firm. The payout ratio helps in deducing the percentage of profit the firm is returning to investors, and the amount it is retaining back for future development and expansion plans.
Dividend Payout Ratio Formula = Dividends Paid/Net Income Reported
Retention Ratio = Dividends Per Share/ Earnings Per Share
Alternatively, you also get the retention ratio by subtracting the value of the payout ratio from 1.
What is the difference between interest and dividends?
Many of you might confuse between interest and dividends paid by firms. There are different entities, and the following table will help you understand the difference between interest and dividends systematically.
| Characteristics | Interest | Dividend |
|---|---|---|
| Definition | Financial institutions earn interest against a sum of money lent to borrowers. | Companies award dividends against the profit earned in a financial year. |
| Nature | Interests get charged against profit. | The dividend is a percentage of profits. |
| Role of Profit | Interest is independent of profits. So, even if borrowers do not earn a profit, they need to pay interest to lenders. | It is essential to make a profit for disbursing dividends. |
| Determines | The interest paid by a company plays a crucial role in the profit earned by it during a fiscal year. | The dividend retention ratio determines the fund available for future expansion plans. |
| Receivers | Lenders, creditors, and debenture holders receive interest from firms. | Equity shareholders and preference shareholders receive dividends from firms. |
| Is it optional? | No, companies need to pay interest against their debts. | Yes, a company may not award dividend if they do not earn sufficient profit. |
| Calculation | The rate and calculation of interest remain fixed and predetermined. | The calculation of dividends depends upon the business strategies of the company. However, it remains fixed for preference shareholders. |
| Tax Benefits | A firm can earn tax exemptions while paying interest to creditors. | Disbursal of dividends does not have any effect on tax exemption. |
Frequently Asked Questions
1. What is a dividend mutual fund?
Dividend mutual funds are mutual funds that mainly invest in companies that pay dividends to their stockholders.
2. Can you sell on the ex-dividend date and get a dividend?
Yes, if you sell the shares on the ex-dividend date, you remain entitled for the granting of dividends. It is because it takes three business day time for your name to get added or removed from the company’s record from the transaction day. As your name is on the company’s record on the ex-dividend day, you will get the dividend.
3. What is a good dividend yield?
Market experts consider a dividend yield between 4 to 6 per cent as a good dividend yield. When the figure surpasses 10 to 12 per cent, investors become critical about the performance and documentation of the firms.
4. Which stock has the highest dividend?
Companies falling under real estate investment trusts (REIT) and master limited partnerships (MLP) have earned the trust of investors as highest dividend payers. Banks and financial institutions, oil and natural gas, basic materials, and pharmaceutical companies also regularly award dividends to shareholders.
5. Why share price drop after dividend?
The share prices of companies fall on the ex-dividend days as firms adjust their assets according to the dividend rate after the announcement. Since a percentage of the profit earned by the concern goes out to the shareholders, its stock price gets reduced.
6. Can you live off dividends?
Yes, you can live off dividends provided you start investing in stocks in the early stage of your life and select healthy and high-yielding shares.
7. How to buy dividend stocks without a broker?
You can invest in dividend stocks without a broker by participating in a firm’s direct stock plan (DSP) and dividend reinvestment plan (DRIP).
