A dividend can be described as a reward that publicly-listed companies extend to their shareholders, and its source is the company’s net profit. Such rewards can either be in the form of cash, cash equivalent, shares, etc. and are mostly paid from the remaining share of profit once essential expenses are met. A company’s board of directors decides the rate of dividend, wherein, the approval of majority shareholders is also factored in.
What is a Dividend?
A dividend is a portion of a company’s profits that is paid out to its shareholders. When a company accumulates retained earnings, management can choose to reinvest in the business to fuel growth, pay off debts, or save for future needs. Alternatively, management can decide to share some of these profits with shareholders. This profit sharing is called a dividend.
Types of Dividend
Special Dividend
This type of dividend is paid on common stock. It is often issued under a particular circumstance when a company has accumulated substantial profits over several years. Mostly such profits are looked at as excess cash that does not need to be used at the given moment or in the immediate future.
Preferred Dividend
Such a dividend is issued to the preferred stock owners and usually accrues a fixed amount that is paid quarterly. Also, this kind of dividend is earned on shares that function more like bonds.
Interim Dividend
Interim dividend is declared by companies before the preparation of the final full-year accounts. Here, in the Indian context, the ‘year’ being referred to is the period between April of one year and March of the next year. This is the duration for one financial year in India.
Final Dividend
A final dividend is declared after the accounts for the year are prepared.
Besides these, the list below highlights the most common types of dividend–
- Cash
Most companies prefer to pay a dividend to their shareholders in the form of cash. Usually, such an income is electronically wired or extended in the form of a cheque.
- Assets
Some companies may reward their shareholders in the form of physical assets, investment securities and real estates. However, the practice of offering assets as dividends is still quite rare among companies.
- Stocks
A company offers stocks as dividends by issuing new shares. Typically, the stock dividends are distributed on a pro-rata basis, wherein, each investor earns dividend depending on the number of shares he/she holds in a company.
- Common Stocks
Typically, it is the profit that is paid to the common stockholders of a company from its share of accumulated profits. The share of this dividend is often decided by the law, especially when the dividend is set to be paid in cash and may lead to the company’s liquidation.
The Importance of Dividends for Investors
Dividends are an essential part of many investors’ strategies, especially those who are looking for a steady income stream from their investments. Companies, mutual funds, and exchange-traded funds that pay regular dividends are often seen as stable and profitable, making them attractive to investors who prefer lower-risk opportunities.
Impact of Dividend on Share Prices
It must be noted that paying dividends to shareholders may not influence the overall value of the business venture. Regardless, such a move tends to lower the overall equity value of the venture by the exact amount that is being paid as a dividend. To further elaborate, dividend once paid out goes debited from the accounting books permanently and is an irreversible move.
Further, when a company declares a dividend, its share prices undergo a significant increase governed by market activities. They are more likely to pay a premium in the hope of earning dividends. However, the share prices start to decline by a similar proportion once the date of dividend eligibility expires. Such a fall usually occurs when new investors are not deemed eligible to receive dividends and are hence reluctant when it comes to paying the associated premium.
Similarly, if the market is anticipated to remain optimistic until an ex-dividend date, the increase in stock’s value may be higher than the dividend offered. Irrespective of reductions, such an occurrence often leads to an increase in the overall value of a company’s stock.
Regardless, to understand the impact of dividend declaration on stock prices individuals need to become familiar with the important dates about dividends.
For instance, the table below highlights the most important dividend dates.
Dates | Importance |
Announcement dates | The company’s board of directors announces the dividend on this date. |
Ex-dividend date | On this date, the dividend eligibility is slated for expiry. |
Record date | Typically, it is the cut-off date when a shareholder’s eligibility income is scrutinised. |
Payment date | On this date, the dividend is credited to investors’ respective accounts. |
FAQs
Calculation of Dividends?
A dividend is calculated by using the dividend payout ratio, wherein, the annual dividend per share is divided by earnings per share. The said ratio can be expressed as –
Dividend Payout Ratio = Dividends paid / Reported net income
Notably, the dividend payout ratio is 0% for those companies who do not offer dividends to their shareholders. Similarly, companies who pay out the total net income as dividends have 0 dividend payout ratio.
Similarly, the retention ratio can be computed by dividing the dividend paid per share with earnings per share. The same can be expressed as –
Retention Ratio = Dividend per share / Earnings per share
Functioning of Dividends?
Step 1 – Publicly-listed companies generate substantial income and accumulate a significant share of retained earnings.
Step 2 – A company’s management decides if they should reinvest their retained earnings or distribute the same among shareholders.
Step 3 – The board members on availing major shareholder’s approval declare dividend on a company’s shares.
Step 4 – Important dates related to dividend declaration are announced.
Step 5 – Shareholder’s eligibility to earn dividend is scrutinised.
Step 6 – The dividend is paid to shareholders.
