What are dividends? Are they compulsory?

Podcast Duration: 05:01
Hello friends and welcome to another informative podcast by Angel One.

Dividends are a happy word and that’s what we’re going to explore today. So what exactly are dividends? Let us illustrate with some happy examples that allow us to reminisce in the bargain. Remember when you brought home a report card featuring an A + back in school? You’d be bursting with pride and hope and your parents – also bursting with pride, probably took you out and bought you a new toy. In college good grades meant new jeans or a new phone. Now at work, meeting your targets means a bonus, or a raise, maybe an incentive trip or at least an award or a pat on the back. All of these were rewards and dividends too are rewards. When a company performs well it rewards its shareholders for having invested in them and this reward is referred to as dividend. For you to end up with dividends, the company should have clocked sizeable profits so as to have excess capital available after

- One: Paying off creditors and settling any debts
- Two: Paying salaries, rent and other expenses related to daily running of a business
- Three: Putting aside money for expansion and other growth efforts
Additionally the dividend payout needs to be
Firstly initiated by the board of directors
The amount and the payout itself need to be approved by the shareholders, You will usually receive your dividend cheque by courier.

Those were the basics but over and above there are 6 key facts that you need to know and understand with regards to dividends. These facts most definitely affect your investment game so pay careful attention. Ready?

Let’s begin with the manner of dividend distribution.
Dividend is always distributed proportionately. If you have 10,000 shares and a 2% dividend is announced you will receive Rs 200 by way of dividend. In the same situation if you had instead 20,000 shares, you would receive Rs 400 by way of dividend.

Second, and very important is the concept of record date.
When a dividend announcement is made, a “record date” is announced along with it and this is the date by which you need to have the company’s shares in hand if you want to receive the dividend. After the record date, the stock becomes ex-dividend and traders purchasing the stock once it is ex-dividend are not entitled to receiving any dividend. It is kind of like how you can’t expect ex-employers to pay you salaries and how you can’t expect ex-boyfriends to buy you flowers on Valentine’s Day.
The third point to keep in mind with regards to Dividend is its relationship with stock price.
Ever dropped chocolate crumbs on your bed amidst your lockdown lounging about and laziness only to find that they have attracted a whole lot of ants? No judgment passed buddy! But just like sugar attracts ants, a dividend announcement attracts demand from other traders. Of course, they don’t bite ….unlike the ants…. but increased demand does drive the stock price upwards. You need to make a calculated choice between waiting for the dividend payout and selling at potentially higher prices between the dividend announcement and dividend payout. Do some quick math to make the right call.

It is also important to note that dividend declaration is no indication of future pricing.
Upon announcement of dividend, stock prices tend to skyrocket due to increased interest and demand. But this is no guarantee that the stock prices will continue to increase after the record date. In fact many traders have a strategy of buying just after the record date in order to get shares at a lower rate as demand tends to plummet once the stock is ex-dividend. But there is no guarantee on when these lowered prices will turn around. Have a roadmap in mind and don’t just jump in blindly.

You also need to acknowledge that dividend is not compulsory.
Just because a company paid dividends every year for the past five years, it does not mean that they will announce a dividend payout this year. Maybe this year the company decides they want to invest in an altogether new market and will thus avoid the dividend payout. It is true that newer companies veer away from dividend payouts because they need the capital for expansion. It is also true that established companies often pay dividend in order to keep shareholders loyal and pleased. But none of this is set in stone and the company can do as they please when it comes to declaring dividends. Predict with caution.

Very importantly – you must not overlook the fact that dividend can very well be taxable.
Up until Annual Budget 2020, dividends of up to Rs 10 lakh were not taxable whereas dividend earnings in excess of Rs 10 lakh were taxable at 10%. This was known as Dividend Distribution Tax and the amount was deducted by the company issuing the dividend, before paying dividend to the shareholder. However Budget 2020 announced that 10% TDS would be deductible even on dividend earnings as small as Rs 5,000. This changes the game tremendously and of course traders need to consider whether earning dividend is a better idea given the tax they will pay – versus selling off the stock at a higher price.

As you have probably noticed through this podcast, dividend announcements could mean a buy sign for some investors and a sell sign for others. Keep your strategy in mind before deciding. Do your own research and definitely refer to company reports as well as charts and indicators before deciding whether to hold or sell your stock. Happy trading!