What are Dividends?

After understanding the intricacies and jargon of different kinds of stock splits in our previous blogs, let us continue our journey of unravelling the corporate actions, let’s dive into another corporate action which is “Dividend”.

Getting a dividend as a shareholder is pretty exciting. I mean, who doesn't like getting some extra cash, right? It's like a little financial bonus that gives the chance to plan out some smart moves, whether it's investing or any other financial moves. Well, we can say Dividends are a gateway to Passive Income.

The language surrounding dividends and their related corporate actions can be complex. So, let's unravel the concept of dividends, exploring their significance, types, and much more.

Understanding Dividends:

Dividends, a key aspect of corporate finance, play a pivotal role in attracting investors. Dividends are financial rewards that companies distribute to their shareholders as a way of sharing profits. These payouts are usually in the form of cash or additional shares (known as bonus shares). Companies typically issue dividends regularly, creating a reliable income stream for investors.

Before getting into the intricacies of Dividend, let us try and explore the different kinds of dividends that a company can offer:

1. Cash Dividends
The most common type is where shareholders receive a portion of the company's profits in cash. For example, let’s say Company X declares a cash dividend of INR 0.50 per share. If you own 100 shares, you receive INR 50.00

2. Stock Dividends
Instead of cash, shareholders receive additional shares of the company's stock. Let’s say Company Y issues a 5% stock dividend. If you own 100 shares, you receive an additional 5 shares. This kind of event particularly takes place in the US Stock Exchanges.

3. Property Dividends 
Shareholders receive assets other than cash or stock, such as a company may offer its shareholders their products or product discount vouchers.

4. Scrip Dividends
Providing shareholders with the option to receive additional shares rather than cash. Shareholders can choose to receive either per share in cash or receive an equivalent value in additional shares.

5. Special Dividends
Irregular and non-routine dividend payments, often declared in response to exceptional company performance or financial windfalls, i.e. A company announces a special dividend after a significant one-time profit.

6. Interim Dividends
Dividends are declared and paid between regular annual meetings, reflecting the company's financial performance during a specific period. A company may declare an interim dividend after a successful quarter, separate from the regular annual dividend.

7. Preferred Dividends
Payments to preferred stockholders, typically at a fixed rate, before common stockholders receive dividends. If a company owes INR 2 per share in preferred dividends, this amount is paid to preferred stockholders before common stockholders receive anything.

Let us now move towards the chronology of dividend payments, here are key dates to consider as far as dividends are concerned:

1. Ex-Dividend Date
The date on or after which a security trades after taking effect of dividend declaration. Ex-date is generally one day before the record date as the Indian market settles in the T+1 timeline; so, for example, if the record date will be May 5^th, 2023. Now, if you have bought the stocks before the ex-date, which is May 4^th, 2023, you will be eligible to get the dividend advantage, and if you have bought after the ex-date, you will not be eligible for dividends.

2. Record Date
The date on which a company reviews its records to determine the shareholders entitled to receive the declared dividend. For example, If the record date is January 15, only shareholders on record as of this date will receive the dividend.

3. Payment Date
The date on which the dividend is paid to eligible shareholders.

Now, after understanding dividends, you may be interested in knowing about companies that consistently distribute dividends. So, let's boil down, there are several dividend-paying companies in a wide range of industries. Dividend payments are often associated with more mature and established companies that generate consistent profits and have a stable financial position.

One interesting trivia, I would like to share here, I just tried running a query on Screener to understand the highest dividend-yielding stocks and surprisingly majority of the stocks that appeared happen to be PSU namely, Coal India, ONGC, Power Grid etc.

It is pertinent to understand that companies that are in their initial stage or growth phase do not prefer coughing out dividends. So, these new-age startups, such as those in the technology or biotech sectors, may not be able to offer regular dividends since these companies may be in the early stages of development and retain earnings for research and development, business expansion, and operational activities.

Now, after this, you might be wondering why in this world a company offer dividend and why does it not keep that money with itself.

So. to understand the rationale behind this, let's consider if there are any benefits to the companies to offer dividends

1. Return Value to Shareholders
Dividends are a way for companies to return value to their shareholders. By distributing a portion of profits, companies reward investors for their ownership and provide them with a tangible return on their investment.

2. Signal of Financial Health
Companies that pay consistent dividends may be seen as financially stable and well-managed. The ability to pay dividends over time can signal to investors that the company has reliable earnings and sufficient cash flow.

3. Cash Utilization
Companies may choose to pay dividends when they have excess cash that is not immediately required for business operations, debt repayment, or reinvestment in the company. This is often the case for mature and established companies

4. Attracting and Retaining Investors
Offering dividends can make a company's stock more attractive to a certain segment of investors. Companies that consistently pay dividends may attract income-focused investors and enhance overall shareholder loyalty.

5. Share Price Support
Regular dividend payments can provide support to a company's stock price. Investors looking for income may be more likely to hold onto shares, contributing to a stable or even rising stock price.

6. Flexibility in Capital Structure 
Dividend payments offer flexibility in a company's capital structure. By distributing excess cash as dividends, a company can avoid accumulating too much cash and potentially enhance return on equity.

Benefits of dividends to shareholders:

1. Income Stream
Dividends can be a regular income stream. This is especially attractive to shareholders seeking regular income, such as retirees or those looking for stable cash flow.

2. Return on Investment
Dividends represent a direct return on investment for shareholders. It's a way for investors to realize a portion of the company's profits without having to sell their shares.

3. Long-Term Wealth Creation
Reinvesting dividends by purchasing more shares can contribute to the compounding of wealth over time. This can enhance the total return on investment for shareholders.

In summary, dividends are a crucial part of investments, providing a consistent income stream. While dividends are attractive, investors should carefully assess factors like the fundamentals of the company. Diversification and a long-term perspective are key to creating a robust & balanced portfolio. In a dynamic market, understanding the dividend’s role and adapting strategies are essential for long-term success.

To understand more about such interesting concepts along with further interesting examples, check out my course on the Basics of the Stock Market.

Until next time !!!