People having elder siblings may have experienced this several times in their childhood. Let’s say there are two brothers, Ram and Shyam. Shyam is the elder brother of Ram. One day their mother gives Shyam some task while leaving for work promising him to pay a nice reward on the completion of the task. Shyam also gets a hand from his younger brother Ram. Their mother arrives in the evening from work and gets super happy after seeing the work completed and immediately rewards Shyam with delicious chocolates. Shyam dances with joy but realizes that even his younger brother had equal rights on those chocolates as had helped him. Thus, Shyam shares his reward with Ram as he also had contributed to the task. Both Ram and Shyam enjoy their rewards with great joy.
The concept of dividends can be explained with the above example. Let’s replace Shyam with a listed company and Ram with its shareholder/investor who contributes funds to the company for its operations and growth. When the company makes a good Amount of profits, it is distributed to its shareholders/investors as they have contributed funds to the company for its business. The chocolates given by Shyam to Ram for his help are the same as the profits shared by the company to its shareholders/ investors. Though the concept looks easy, there is much more to learn about it. So, let’s dig in!
Dividends are payments made to shareholders from a company's profits. When a company earns excess profits beyond what is needed for operations and growth, it can choose to distribute a portion of these profits to shareholders as dividends. This distribution can be in the form of cash, additional shares of stock, or other property.
Cash Dividends: Cash dividend is the distribution of funds or money paid to stockholders generally as part of the corporation's current earnings or accumulated profits.
Stock Dividends: Instead of cash, shareholders receive additional shares of the company. This increases the number of shares owned without changing the total value of the investment. They are also known as bonus shares.
Special Dividends: These are one-time payments made by a company, often after a particularly strong financial performance or the sale of an asset. They are not expected to be repeated regularly and are usually higher than regular dividends.
Preferred Dividends: Paid to holders of preferred stock, these dividends are usually fixed and must be paid out before any dividends are paid to common stockholders.
Companies adopt various dividend policies based on their financial situation and strategic objectives:
Stable Dividend Policy:
Companies pay a regular dividend amount regardless of fluctuations in earnings. This policy provides certainty to investors but requires stable and predictable cash flows.
Residual Dividend Policy:
Dividends are paid from residual earnings after funding all profitable investment opportunities. This policy ensures that dividends do not compromise future growth prospects.
Constant Payout Ratio:
A fixed percentage of earnings is paid out as dividends each period. This policy adjusts dividend payments in line with earnings fluctuations, providing a steady income relative to earnings.
Hybrid Dividend Policy:
It is a combination of the residual and stability dividend policies. It can involve paying a supplemental dividend when business conditions are good, or it can be a combination of cash and stock dividends to satisfy investors
Rewarding Shareholders:
Dividends are a way for companies to distribute a portion of their profits directly to shareholders. By paying dividends, companies reward shareholders for their investment in the company. This can enhance shareholder loyalty and satisfaction, encouraging them to hold onto their shares and potentially attract new investors seeking income.
Attracting Investors:
Dividend-paying stocks are often attractive to investors, particularly those seeking regular income streams. Companies that consistently pay dividends signal financial stability, profitability, and confidence in future earnings. This can increase demand for the company's stock, potentially leading to a higher stock price and lower cost of capital.
Tax Efficiency:
In some jurisdictions, dividends receive preferential tax treatment compared to other forms of income, such as interest or capital gains. This tax advantage can make dividend-paying stocks more attractive to investors, especially those in higher tax brackets.
| High Dividend Yielding Stocks | Dividend Yield (%) | PE (X) | Returns YTD (%) | 1 Year Returns (%) |
|---|---|---|---|---|
| Nirlon | 5.9 | 19.4 | 9 | 23 |
| Coal India | 5.8 | 9.21 | 20 | 109 |
| 360 One Wam Ltd | 5.5 | 30.23 | 4 | 14 |
| Power Grid Corporation | 5 | 16.45 | 14 | 67 |
| Oil India | 4.3 | 8.24 | 30 | 118 |
| VST Industries | 4.1 | 19.95 | -6 | 20 |
| Swaraj Engines | 3.9 | 20.71 | -2 | 24 |
| HCL Technologies | 3.9 | 27.37 | 9 | 14 |
| Gujarat Pipavav Port | 3.8 | 25.79 | 7 | 10 |
| Petronet LNG | 3.7 | 11.52 | 26 | 39 |
| Polyplex Corporation | 3.5 | 44.52 | -712 | -33 |
| Oracle Financial Services | 3.4 | 26.59 | 6 | 119 |
| Tech Mahindra | 3.3 | 24.9 | 0 | -3 |
| Castrol India | 3.3 | 22.71 | 1 | 8 |
| CESC | 3.2 | 12.95 | 8 | 51 |
| Heidelberg Cement India | 3.1 | 31.71 | -4 | 32 |
the short term, dividends can influence market dynamics and investor behaviour. Some of the key short-term impacts are:
Stock Price Volatility:
Dividend announcements or changes can impact stock prices. Increases in dividends often lead to positive stock price reactions, reflecting investor confidence and attractiveness for income-seeking investors.
Income Generation:
Dividends provide immediate financial benefits to investors relying on regular income. This income can stabilize portfolios during market downturns or economic uncertainties.
Tax Considerations:
Changes in dividend tax rates or policies can influence investor decisions and stock prices, affecting market liquidity and demand for dividend-paying stocks.
Over the long term, dividends contribute to sustainable growth and shareholder value:
Total Return Enhancement:
Dividends significantly contribute to total returns from equity investments, especially when reinvested. Over time, compounding dividends can generate substantial wealth accumulation.
Capital Allocation and Efficiency:
Dividend policies influence how companies allocate capital between dividends, reinvestment in the business, debt reduction, or share buybacks. Well-managed dividend policies optimize capital allocation to enhance shareholder value.
Capital Allocation and Efficiency:
Dividend policies influence how companies allocate capital between dividends, reinvestment in the business, debt reduction, or share buybacks. Well-managed dividend policies optimize capital allocation to enhance shareholder value.
Market Valuation:
Dividend yield (dividend per share divided by stock price) influences how investors value stocks, especially in low-interest-rate environments. High-dividend-yield stocks may attract investors seeking income, impacting stock valuation.
Dividends play a pivotal role in investment strategy, providing income, stability, and long-term growth potential for investors. Understanding different dividend policies helps investors evaluate companies' financial health and management priorities. Whether seeking immediate income or long-term wealth accumulation, dividends offer compelling benefits that align with diverse investment objectives. By comprehending the impacts of dividends over both short and long terms, investors can make informed decisions to optimize their portfolios and achieve financial goals effectively.
