Any reward given by a company to its shareholders, whether in cash payment or stocks, is called a dividend. Companies that regularly earn profits may distribute them as dividends to their shareholders on a monthly, quarterly or annual basis. However, it is not mandatory for any company to issue dividends.
The dividend is either a portion of the company’s profits or taken from its reserves as a part of an agreement between the company and shareholders. The company’s board of directors decides the dividend declaration after approval from shareholders. Regular dividend income increases investors’ confidence in the company, which increases its share price.
When a company earns profits, it can choose to reinvest in its business or reward its shareholders after paying its creditors. A company offers a bonus in the form of liquid cash, stocks or other benefits to encourage more investments.
Today, many companies and AMCs (Asset Management Companies) have adopted the practice of paying dividends. Dividend payouts are a gesture of goodwill and are not compulsory for any business. They can skip paying dividends when they face cash shortages or need cash for reinvestments.
When a company wants to distribute its profits, its management team, along with the board of directors, approve the planned dividend. Then, they announce the record date, value per share and date of issue of the dividend. Anyone who bought shares within this record date is eligible for dividend income in proportion to his/her shareholding.
The company usually mails the cheques of the dividends to shareholders within a week or so of announcing them. One can buy or sell stocks with dividends within two days before the record date, and then they turn into ex-dividend, i.e. they do not generate dividend income.
The following are the various types of dividends that companies can pay to their shareholders.
Mature companies earning regular returns over several years pay out dividends to their shareholders. Their primary reason is to increase the value of their stocks and attract new investors. In addition, they do this to reassure shareholders about the company’s financial status.
Investors see dividend payouts as a sign of a business’s underlying value. Regular dividend payments increase investors’ confidence as it sends a positive message about its future prospects. New investors are also interested in the stocks of a company offering regular dividend income.
Stocks with a high dividend yield offer a steady source of income from the company’s profits. Stockholders can use them for immediate profits or reinvest to buy additional shares of the company.
Many established companies disburse their annual profits among investors every year to establish their goodwill. Investors see the dividend yield of a company to assess its underlying value.
Companies issuing dividends usually have a strong market presence and the ability to generate profits consistently. Dividends are also a strong sign of a company’s reliability and an indicator of profitability in the future. Hence, these stocks typically carry lower risks than growth stocks.
Dividend stocks are usually less prone to market volatilities as the companies are strong and steady with sufficient cash flow. Thus, many investors simply buy and hold these stocks due to their stable nature.
Companies that pay high dividend income and grow their earnings tend to produce attractive returns. Investors can use the money from dividends to buy more shares and reap the benefits of higher yield in the future.
From FY2020-21, any dividend from shares of Indian companies is taxable in the country. In the case of resident Indians, dividend income is added to their taxable income and taxable as per their income tax slab rates. Previously, companies issuing dividends had to pay a dividend distribution tax (DDT) on their payouts.
The dividend income for NRIs (Non-Resident Indians) has a 20% tax applicable plus surcharge and a 4% health and education cess. They may also benefit from any DTAA (double taxation avoidance agreement) between India and the country of their residence. This allows them to avoid double taxation.
Income from dividends is also subject to TDS (Tax Deducted at Source) of 7.5% for dividends greater than Rs. 5,000 in a financial year. The Indian government cut the rate from 10% in March 2021 due to the COVID-19 pandemic.
Some companies offer dividend income as an incentive for investors to buy their stocks. Investing in such stocks is a great way of earning a steady income while benefitting from capital appreciation.
Dividend-yielding stocks generally carry less risk as they have to regularly generate profits to offer dividends. However, investors should do their due research before investing and not judge a company’s value on dividend payouts alone.
Ans: The dividend yield is the percentage of dividends issued per share in a year against its current share price. This value indicates the amount of money one might receive from a company based on its current price. Investors use this figure to compare a stock’s relative value against its market peers.
Ans: A high dividend yield is not a good enough indicator for purchasing stocks. For example, a company offering a high dividend yield when its share price is low may be experiencing financial troubles.
On the other hand, a company with a low dividend yield may be focusing on growth and investment, which is better for it in the long run. Therefore, companies cannot have good or bad dividend yields.
Ans: While a company not paying dividends may be experiencing financial troubles, there are several good reasons like the following to not pay dividends:
• Well-established companies often reinvest their earnings to pay off debt and fund new initiatives.
• From a fiscal point of view, it makes more sense for a business to reinvest in its operations.
• Expanding companies will not want to spend their funds during pivotal growth stages.
Ans: Yes, a failing company may want to attract new investors with a high dividend yield. By offering such attractive deals, it can increase its stock price to get out of financial trouble. Therefore, investors might want to check a company’s earnings growth and other fundamentals before investing.
Ans: No, paying dividends is not an obligation for any organisation. It is entirely up to the company to decide if it wants to continue paying dividends to shareholders or avoid such payments. Lack of profits, necessary spending, plans for expansion or an increase in tax rates are some reasons for a company to cut its dividend payouts.
Want to put your savings into action and kick-start your investment journey 💸 But don’t have time to do research? Invest now with Navi Nifty 50 Index Fund, sit back, and earn from the top 50 companies.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
10 Best SIP Plans for 1000 Per Month in India 2023Systematic Investment Plan (SIP) is an investment style or route with which you can invest a fixed ... Read More »
How to Invest in Mutual Funds in India – Easy StepsMutual funds can be an excellent way to diversify your portfolio and gain exposure to a wide range ... Read More »
20 Best Nifty 50 Index Funds in India to Invest in April 2023What is the Nifty 50 Index Fund? Nifty 50 index funds are a type of passively-managed equi... Read More »
Asset Management Company (AMC) – Types and BenefitsWhat is an Asset Management Company (AMC)? Asset Management Company or AMC is a financial ... Read More »
10 Best Gold Mutual Funds to Invest in India (April 2023)Gold Mutual Funds are funds that invest in gold and gold-related assets such as bullion, coin... Read More »
20 Best Flexi Cap Mutual Funds to Invest in India 2023Flexi-cap funds are mutual fund schemes that aim to invest in stocks of companies across market cap... Read More »
Best SIP Plans for 15 years – Top 10 SIP Plans to Invest in India 2023A systematic investment plan (SIP) could be a convenient mode or style of investing in mutual funds... Read More »
10 Best SIP Plans for 1 year Investment in India 2023There has been a massive surge in SIP or Systematic Investment Plan investors in recent years. As p... Read More »
10 Best SIP Plan for 3 Years in India to Invest in 2023SIP or Systematic Investment Plan helps bring investment discipline in an investor’s life. It’s... Read More »
10 Best SIP Plan for 10 years India in 2023 – Returns and PerformanceAsk any beginner mutual fund investor and most of them would tell you that their preferred mode of ... Read More »