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.
Read on to understand how dividend income works, its types, taxation and reasons to choose stocks offering dividends.
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.
Also Read: Dividend Yield: Meaning & How To Calculate
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.
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.
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.
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.
While a company not paying dividends may be experiencing financial troubles, there are several good reasons like the following to not pay dividends:
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.
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.
Before you go…