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Dividends are payments which are made by companies to shareholders from their profits. They are a crucial part of overall equity returns. Dividends are frequently viewed by investors as indicators of financial stability and consistent cash flows. Understanding the various types of dividends allows investors to evaluate a company’s announcements, analyse income possibilities, and compare companies.
Key Takeaways
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Listed companies must publish dividend distribution policies in their annual reports, increasing openness for income investors.
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Dividend income is added to your total income and taxed at the appropriate income tax slab rates, which can be up to 30% plus surcharge and cess.
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Even for very high-income taxpayers, the highest tax surcharge rate on dividend income is 15%.
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There is no specific deduction for dividend income under Section 80C of the Income Tax Act, 1961.
Understanding the Meaning of Dividends
Dividends are regular payments made by a company to its shareholders as a way to distribute a portion of its profits. When a company generates earnings, it may choose to allocate a portion of those profits to shareholders in the form of dividends. These payments can be made in cash, additional shares of stock, or other assets.
Dividends serve as a reward for shareholders who have invested in the company, providing them with a tangible return on their investment. They are typically paid out quarterly or annually, depending on the company's financial performance and dividend policy. Dividends are an essential component of many investors' strategies, as they offer a steady stream of income and can contribute to long-term wealth accumulation.
Also Read: What is a Shareholder?
Different Types of Dividends
1. Cash Dividend
This is a common type of dividend that companies distribute to their shareholders in the form of cash payments. When a company generates profits, it may choose to distribute a portion of those profits back to its shareholders as cash dividends. They are typically paid on a per-share basis, meaning that shareholders receive a certain amount of cash for each share they own.
For example, if a company declares a cash dividend of ₹10 per share and an investor owns 100 shares, they would receive a cash payment of ₹10*100 = ₹1,000. Cash dividends are usually paid out regularly, such as quarterly, semi-annually, or annually, depending on the company's dividend policy.
2. Stock Dividend
Stock dividends are a type of dividend payment in which a company distributes additional shares of its own stock to existing shareholders instead of cash. These are often used by companies to conserve cash while still rewarding shareholders.
For example, if a company announces a 10% stock dividend and an investor owns 100 shares,
they would receive an additional 10 shares (10% of 100 shares) as a stock dividend. As a result, the investor's total number of shares would increase to 110. The value of each share may decrease proportionally to account for the new shares issued.
3. Property Dividend
Property dividends are a type of dividend payment in which a company distributes assets or property to its shareholders instead of cash or additional shares. Instead of receiving cash or stock, shareholders receive tangible or intangible assets, such as inventory, real estate, intellectual property, or subsidiary company shares.
Property dividends are less common than cash or stock dividends and are typically issued when a company has excess assets that can be distributed among its shareholders. This type of dividend allows the company to monetise its assets or transfer ownership of certain assets to its shareholders.
For example, a real estate development company may distribute properties or rental units to its shareholders as property dividends. Shareholders would then become owners of those properties and may choose to sell, lease, or retain them as per their discretion.
4. Scrip Dividend
Scrip dividends are quite similar to stock dividends. In this, instead of additional shares, the shareholder will be getting scrips or vouchers that can be redeemed for shares on the market. Importantly, scrip dividends often involve deferred equity issuance, as the actual conversion into shares may be postponed based on the terms of the voucher.
They are a type of dividend payment in which a company issues additional shares of its own stock to its shareholders instead of cash or property. Instead of receiving a cash payout, shareholders receive additional shares of the company's stock based on their existing shareholding.
For instance, if a company declares a scrip dividend of 10% and a shareholder owns 1,000 shares of the company, the shareholder would receive an additional 100 shares (10% of 1,000 shares) as a scrip dividend. The shareholder can hold on to these additional shares or choose to sell them in the market.
5. Liquidating Dividend
Liquidating dividends are given by a company when it is in the process of liquidating its assets and winding up its operations, and therefore, cannot pay in the form of other dividends. Unlike regular dividends that are paid out of a company's profits, liquidating dividends are paid from the company's remaining assets after all debts and liabilities have been settled.
It's important to note that liquidating dividends is typically subject to specific legal and regulatory requirements. The distribution of assets must follow the prescribed procedures outlined by the applicable laws and regulations governing the liquidation process.
For example, if a company decides to liquidate and has ₹10 million in assets remaining after paying off all debts and liabilities, it may distribute these assets as liquidating dividends to its shareholders.
Impact of Dividends on Share Prices
Dividends can have an impact on share prices in several ways. A dividend announcement or increase can send a positive signal to investors, reflecting the company's profitability and confidence in its future prospects, which can lead to increased demand for the stock and potentially drive up the share price. This can also attract income-seeking investors who rely on regular dividend payments for their investment income.
The expectation of consistent and attractive dividend payments can make a stock more desirable, increasing demand and potentially influencing the share price positively. Additionally, dividend capture strategies, dividend reinvestment, and the dividend yield relative to other stocks in the market can also affect share prices.
How are Dividends Calculated?
The company's board of directors declares the dividend. It is based on factors such as the company's profitability, financial health, and dividend policy. The calculation can be done on a per-share basis or as a total payout.
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For the per-share calculation, the total dividend amount is divided by the number of outstanding shares to determine the dividend per share.
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The total dividend payout can be calculated by multiplying the dividend per share by the total number of shares held by shareholders.
Depending on the type of dividend paid, the calculation is made.
Functioning of Dividends
Understanding how dividends function helps investors know when and how payouts occur and how they may affect shareholding value:
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Dividends work differently depending on their type; for example, stock dividends increase the number of shares, whereas cash dividends include direct cash transfers to shareholders.
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Companies that have adequate retained earnings and profits may opt to distribute a portion of those profits as dividends to shareholders.
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The dividend is legally declared by the board of directors, who define the dividend amount as well as the record and ex-dividend dates.
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Dividend distributions can take several forms, such as cash, more shares, or other assets, depending on the kind stated.
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The ex-dividend date defines which shareholders are entitled to the next dividend; shares acquired on or after this date are normally ineligible for the most recent distribution.
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Once the dividend is announced, it is paid on the specified payment date, either by an electronic transfer for cash dividends or by crediting shares to the shareholder's Demat account.
Also Read: What is Demat Account
Importance Of Dividends in Financial Modelling
Dividends play a significant role in financial modelling as they impact a company's cash flows and valuation. In financial models, dividend calculations involve projecting the amount and timing of dividend payments based on factors like dividend policies, payout ratios, and growth rates. These projections help assess a company's financial performance and shareholder returns.
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In an income statement, dividends have no impact on Profit After Taxes (PAT) as they are a distribution of profits.
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In a balance sheet, there will be a rise in liabilities due to the dividend payable amount. And also, the retained earnings and cash will be reduced.
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In a cash flow statement, the dividend payments are under the ‘financing activities’ section as an outflow from the company.
Dividend Payout Ratio vs Dividend Yields
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Parameter |
Dividend Payout Ratio |
Dividend Yield |
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Definition |
It is the percentage of earnings paid out as dividends |
These are dividend returns earned relative to the current share price |
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Formula |
Dividend per share ÷ Earnings per share |
Dividend per share ÷ Market price per share |
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Indicates |
Profit distribution policy |
Income return on investment |
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Investor Use Case |
Assess the sustainability of the dividend policy |
Compare dividend returns across stocks |
Conclusion
Dividends are a significant means for companies to distribute their profits while also providing shareholders with a stable revenue stream. Understanding the different types of dividends is crucial to better analyse company activities, assess financial soundness, and compare firms based on dividend behaviour. Apart from this, investors should also take into account the financial statements, distribution consistency, and overall market circumstances before making an investment decision.
