A dividend is a distribution of a company’s earnings to its shareholders that is determined by the board of directors of the company. Dividends are typically paid out quarterly and can be paid in cash or in the form of additional stock reinvestment.
The dividend yield is expressed as dividend/price as a percentage of a company’s share price, for example, 2.5%.
Common shareholders of dividend-paying companies are entitled to a distribution if they own the stock prior to the ex-dividend date.
Important Points
- A dividend is the distribution of a company’s profits to its eligible shareholders.
- The board of directors of a company decides on dividend payments and amounts.
- The dividend yield is the dividend per share expressed as a percentage of the share price of a company.
- Many businesses do not pay dividends and instead retain earnings to reinvest in the business.
Dividends: An Introduction
Dividends must be approved by shareholders using their voting rights. Although cash dividends are the most common, dividends can also be issued in the form of stock shares. Dividends are also paid by mutual funds and exchange-traded funds (ETFs).
A dividend is a money paid to shareholders in exchange for their investment in a company’s equity, and it is usually derived from the company’s net profits. Though profits can be retained by the company as retained earnings to be used for ongoing and future business activities, the remainder can be distributed to shareholders as a dividend.
Companies may still make dividend payments even when they don’t make suitable profits to maintain their established track record of distributions.
The board of directors has the authority to issue dividends over a variety of time periods and at various payout rates. Dividends can be paid at regular intervals such as monthly, quarterly, or annually. In India Coal India, SBI, NMDC and in USA Walmart Inc. (WMT) and Unilever (UL), for example, pay regular quarterly dividends.Companies can also issue non-recurring special dividends, either individually or in addition to a scheduled dividend.
Important Dividend Dates
Dividend payments are made in the chronological order of events, and the dates are important in determining which shareholders are eligible to receive the dividend payment.
- Announcement date: Dividends are declared by company management on the declaration date (or announcement date) and must be approved by shareholders before they can be paid.
- Ex-dividend date:The ex-dividend date, or simply the ex-date, is the date on which dividend eligibility expires. For example, if a stock has an ex-date of Monday, May 5, shareholders who purchase the stock on or after that date will NOT be eligible for the dividend. Shareholders who own the stock one business day before the ex-date, Friday, May 2, or earlier, are eligible for the distribution.
- Record date:The record date is the deadline set by the company to determine which shareholders are eligible for a dividend or distribution.
- Payment date: The dividend is paid by the company on the payment date, which is when the money is credited to investors’ accounts.
How Do Dividends Affect Stock Prices?
Dividend payments have an effect on share price, and the price may rise on the announcement by approximately the amount of the dividend declared, just to fall by a similar amount at the opening session of the ex-dividend date.
For example, a company with a share price of $60 declares a $2 dividend on the announcement date. As the news spreads, the share price could rise by $2 to $62.
If the stock is trading at $63 one business day before the dividend is payable. Because anyone buying on the ex-dividend date will not receive the dividend, it is adjusted by $2 and begins trading at $61 at the start of the trading session on the ex-dividend date.
This is not guaranteed, but the price is frequently adjusted by the dividend on the ex-dividend date.
Why Do Companies Pay Dividends?
Dividends are frequently expected as a reward for shareholders’ investment in a company. Dividend payments reflect positively on a company and support in the retention of investors’ trust.
A large dividend declaration can indicate that the company is doing well and making money. However, it may also indicate that the company lacks suitable projects to generate higher returns in the future. As a result, it is using its cash to pay shareholders rather than reinvesting it in growth.
A company with a long history of dividend payments that declares a dividend reduction or elimination may signal to investors that the company is in trouble.
However, a reduction in dividend amounts or a decision not to pay dividends is not always bad news for a company. The company’s management may have a plan for investing the funds, such as a high-return project that has the potential to increase long-term returns for shareholders.
How to Buy Dividend-Paying Investments
Dividend investors have several choices, including stocks, mutual funds, and exchange-traded funds (ETFs). The dividend discount model and the Gordon growth model can aid in stock selection. To value shares, these techniques rely on expected future dividend streams.
Investors can use the dividend yield factor to compare multiple stocks based on their dividend payment performance, which measures the dividend as a percentage of the current market price of the company’s share.
The dividend rate is expressed in terms of the dollar or ruppes amount received as dividends per share (DPS). The total return factor, in addition to dividend yield, is an important performance measure for evaluating the returns generated by a specific investment. This figure includes interest, dividends, and share price increases, among other capital gains.
Another important factor to consider when investing in dividend gains is taxation. Dividend-paying stocks are often preferred by investors in high tax brackets if their jurisdiction allows for zero or comparatively lower dividend tax.