What is a dividend? And How to make best use of it?
What is a dividend? And How to make best use of it?
Everyone deserves reward for hardwork. After a long day’s work, there is no better reward than a nice steaming cup of tea/coffee.
Likewise companies also give out rewards to those who show trust and invest in their company. This reward is called a dividend.
So today, let’s discuss dividends.
What is a dividend?
Dividends are a very debated topic amongst investors of all kinds. So, let’s just understand what exactly these are.
When you buy the stock of a company, you become a part owner of the company. You are a part of the prosperous future the company wishes to build for itself. Hence, you are also entitled to whatever profits it decides to redistribute as a reward for believing in its business and investing in it. This reward is termed as a dividend.
When a business reports a profit, after putting aside all its big and small expenses, and future investment plans, it gives back some amount to its shareholders. This is called a dividend.
So in simple terms, A dividend is the distribution of company’s profits to shareholders.
Although cash dividends are the most common, dividends can also be issued as shares of stock or other property.
Are dividends compulsory?
Now, is this compulsory? Of course not. Stocks don’t owe us anything. We’re not lending our money to the company when we buy its stock. So, unlike a bond, or giving a loan to someone, a company does not always have to give out dividends. Some of the biggest companies in the world, such as Amazon, Tesla or Google, haven’t paid a single dividend till date. They say that they plan to use this money as a reinvestment in the business to grow their company.
Are dividends always good for investors?
Now, is a dividend always good? That depends on your approach as an investor. If you’re an investor interested in fast growth and not fixed income, you might prefer a stock that doesn’t pay attractive dividends but grows the company faster.
From the company perspective, if a company grows fast enough, and has a good expansion potential, it can choose to give a smaller dividend or nothing at all. But sometimes, companies are cash-rich and have met their expansion needs. In such cases, giving a dividend is affordable and sustainable.
But what if a company announces a huge dividend?
Do you know that at times, companies pay really big dividends when they shut down. Majesco is an example of that. Since the owners were selling off the U.S. Division of the company, they declared a dividend of Rs. 974, when the share’s price was only Rs. 900–950. And if you know anything about dividends, you would know that the average dividend yield in India is just 1.57%. This means that the percentage taken when a dividend on a stock is divided by its price, comes down to 1.57%, which isn’t a lot.
Impact of Dividends on Share Price
Since dividends are irreversible, their payments typically lead to money going out of the company’s books and accounts of the business forever. Therefore, dividend payments impact share price, which will decline by the dividend amount at the opening session of the ex-dividend date.
For example, a company that is trading at 600 per share declares a 20 dividend on the announcement date. Say the stock trades at 605 one business day prior to the ex-dividend date. On the ex-dividend date, it’s adjusted by 20 rupees and begins trading at 585, at the start of the trading session on the ex-dividend date as dividend amount is going out of company and hence reduces company’s value.
Important Dividend Dates
Dividend payments follow a chronological order of events and the associated dates are important to determine the shareholders who qualify for receiving the dividend payment.
- Announcement date: Dividends are announced by company management on the announcement date, or declaration date, and must be approved by the shareholders before they can be paid.
- Ex-dividend date: The date on which the dividend eligibility expires is called the ex-dividend date or simply the ex-date. For instance, if a stock has an ex-date of Monday, May 5, then shareholders who buy the stock on or after that day will NOT qualify to get the dividend as they are buying it on or after the dividend expiry date. Shareholders who own the stock one business day prior to the ex-date — that is on Friday, May 2, or earlier — will receive the dividend.
- Record date: The record date is the cutoff date, established by the company in order to determine which shareholders are eligible to receive a dividend or distribution.
- Payment date: The company issues the payment of the dividend on the payment date, which is when the money gets credited to investors’ accounts.
Note: Dividends paid by mutual funds are different from dividends paid by companies. Company dividends are usually paid from profits that are generated from the company’s business operations. But when it comes to MF, it isn’t the case.
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