What is Dividend?

Sweet Rewards: Understanding Dividends

Imagine investing in your favourite local bakery. Every year, as the bakery grows and earns more profit, the owner decides to share a slice of the profits with you for being a loyal supporter. This "thank you" for your investment is similar to how companies reward their shareholders with dividends, a slice of their earnings.

Dividends are a fundamental concept in investing, representing the tangible benefits of owning shares in a company. They are more than just periodic payments; they signify a company’s health, profitability, and commitment to its investors. They're the sweet rewards that can make your portfolio sing.

In this chapter, we'll explore the world of dividends – what they are, how they work, and why they matter. We'll uncover the different types of dividends, the significance of a company’s dividend policy, and how dividends impact stock prices.

So, whether you’re a seasoned investor or just starting, understanding dividends will help you make informed decisions and enjoy the sweet rewards of your investments.

Let's understand the types of dividends:

Dividends are usually paid on a regular basis, such as quarterly or annually, and are decided by the company's board of directors. There are two main types of dividends:

1) Cash Dividends: These are the most common form of dividends, where companies distribute a portion of their earnings directly to shareholders in cash. For example, if a company declares a cash dividend of INR 10 per share and you own 100 shares, you will receive INR 1,000.

2) Stock Dividends: Instead of cash, companies may issue additional shares to shareholders. For example, if a company declares a stock dividend of 5%, you will receive 5 additional shares for every 100 shares you own.

Why do Dividends Matter?

Dividends play a crucial role in attracting and retaining investors. Here’s why they are important:

• Income Generation: Dividends provide a steady stream of income, especially for retirees, making them a reliable investment choice.

• Signal of Financial Health: Consistent dividend payments indicate a company's profitability. For instance, companies like TCS and Infosys, which consistently pay dividends, are often viewed as financially sound and well-managed.

• Attraction for Investors: Dividend-paying stocks can attract income-focused investors. High dividend yields can make a stock more attractive compared to other investment options like bonds or savings accounts.

• Tax Benefits: In India, dividends were previously subject to Dividend Distribution Tax (DDT), but now they are taxed in the hands of shareholders according to their income tax slabs. This change has made dividends more attractive for investors in lower tax brackets.

Understanding a Company's Dividend Policy

Each company has its own strategy for dividing profits. Their dividend policy dictates how much will the shareholders get and how much of it will be reinvested in the company's growth. This policy varies depending on factors like financial health, growth prospects, and industry standards.

Examples of Dividend Policies in India

• Consistent Dividend Payers: Companies like ITC Ltd. and Hindustan Unilever Ltd. are known for their consistent dividend payments. These companies prioritize rewarding shareholders regularly, reflecting their stable earnings and strong cash flows.

• Variable Dividend Payers: Some companies may pay dividends based on their annual profits and business needs. For example, Reliance Industries Ltd. has a variable dividend policy where the payout can change each year depending on its financial performance and investment requirements.

• High Dividend Yield Stocks: Stocks with high dividend yields are attractive to income-focused investors. For example, Coal India Ltd. has historically offered high dividend yields, making it a popular choice among dividend investors.

When and How Dividends are Paid?

The dividend payment process follows specific steps:

1) Declaration Date: The date on which the company's board of directors announces the dividend payment.

2) Record Date: The date set by the company to determine eligible shareholders for the dividend. Only shareholders on the company's books will receive the dividend on this date.

3) Ex-Dividend Date: The date on which the stock starts trading without the dividend. Investors who purchase the stock on or after the ex-dividend date will not receive the declared dividend.

4) Payment Date: The glorious day when shareholders receive their dividend payout!

Impact of Dividends on Stock Prices

Dividends can influence a company's stock price. The stock price typically drops by the dividend amount on the ex-dividend date. This is because the company’s assets decrease by the dividend payout, and new buyers are not entitled to the dividend.

For example, if a company declares a dividend of INR 5 per share, and its stock is trading at INR 100, the stock price may drop to INR 95 on the ex-dividend date.

Case Study: TCS

Tata Consultancy Services (TCS) is an excellent example of a company with a strong dividend policy. TCS has consistently paid dividends, reflecting its robust financial health and commitment to returning value to shareholders. For the financial year 2020-21, TCS declared a total dividend of INR 38 per share, showcasing its ability to generate substantial profits and reward its investors.

Conclusion

Dividends are a vital component of an investor’s return on investment. By understanding dividends, investors can make informed decisions about their investments and choose companies that align with their income and growth objectives.

Next, we will explore another corporate action that rewards shareholders: bonus issues. We’ll uncover bonus issues, how they benefit shareholders, and their significance in the Indian market.