What is a Dividend?
A dividend is basically the share of profits and earnings a company pays out to its shareholders. As the company produces profit and accumulates its revenues, the gains can either be reinvested back into the business or paid out to shareholders in the form of a dividend. There is another term known as dividend yield, which is the annual dividend per share divided by the share price.
Two types of Dividends
Regular dividends – These types of dividends are paid to the shareholders consistently over time as and when the company is able to generate profits. A company is able to pay regular dividends both in its good and bad years. Regular dividends are typically paid quarterly, i.e. once every three months.
Special dividends – These types of dividends are usually considered as “one-off.” A company, after generating a series of profitable quarters might decide to pay a special dividend. A company might even pay a special dividend after it has got some cash by selling off some of its assets and does not need that money. A special dividend is also funded by the company to give a message that currently it is sending cash to its shareholders. The shareholders should not expect that the dividend will be paid regularly from then.
How are Dividends paid?
Dividends are paid and declared on per share basis. If a company wants to pay out $3 billion in dividends and outstanding shares available with the company are 1 billion, it can decide to pay out a dividend of $3 per share or $0.75 per quarter. If it decides to pay monthly, then they would need to pay a dividend of $0.25 instead of $0.75 quarterly or an annual dividend of $3.
Before, investors were sent dividend cheques to their mail. If you were a shareholder of Disney in 1990, your ownership proof would be a paper stock certificate. You would receive quarterly dividend cheques with Mickey Mouse printed on the top.
Today physical paper certificates and dividends cheques are not very common, in fact non existent. Most of the stocks are held electronically through a Demat and brokerage account. So when any company issues a dividend, it goes directly into their brokerage account. In this, it only saves cost but also makes tracking and accounting for dividend payments much easier.
Important dates concerning Dividends
Declaration of dividend happens weeks or months before actually paying them. Some important dates one needs to know concerning dividends are:-
- Date of Declaration-This is the day when the company comes out and makes an official announcement that it has decided to issue dividends to its shareholders in the future. It’s the least important date in all the dates.
- Date of Payment-This the date when the dividend is actually given to the shareholders. On this day, payment cheques are mailed to the customer, or the account balance is updated in their brokerage account.
- Record date-This is the date from when you become the official owner of the stock and are entitled to receive the declared dividend payment. As per the Stock Exchange rules, you must own a stock two days before the record date to receive the dividend.
- Ex-dividend Date – On this day, the stock trades “ex-dividend” or without the dividend payment in question. In order to receive a dividend, you must have owned the stock on a business day before the ex-dividend date.
Working of Dividend – Steps Involved
- The company generates profits from its revenues.
- The management decides to lend excess profits and be paid out to its shareholders instead of reinvesting in the company.
- The board then approves the planned dividend.
- The company then gives the date of declaration and announces value per share, payment date, record date etc.
- Finally, a dividend paid to the shareholders.
How are Dividends taxed?
Taxation for dividends is complicated. However, if the dividend stocks and mutual funds are held in a retirement account, it will be great relaxation from taxation. That’s because as per the Securities Exchange Board, retirement accounts are exempt from capital gains taxes and dividend taxes. It is always good to earn money from dividends than to work. And dividend income is generally taxed much lower than long term capital gains tax. the majority of C-corporations pay dividends. When dividends are paid to the shareholders, the tax rate ranges from 0% to 20%. It depends on how much you have earned. Getting into every tax slab of dividend and its details are beyond the scope of this article.
Use of a Dividend
A Dividend is primarily used in financial modelling and in understanding how it impacts a company’s balance sheet, cash flow statement, revenue statement and profit. For example, if a company is going to pay dividends in 2021, then there will be predictions of what the dollar value will be. This is reflected by the money flow out of the company. It also affects the cash flow statements and reduces the cash balance.
Dividend stocks must and should have a place in every investor’s portfolio. It does not matter if you are a retiree who likes steady income growth or a job holder who wants to boost his returns through reinvesting or portfolio diversification.
Always consider investing in companies with steady growth and increasing dividends. But keep in mind to look for quality businesses having bright long-term prospects rather than just chasing high dividend issuing stocks.