Dividend – What is Dividend | Definition and Types of Dividend Stocks

Dividends represent a portion of a company's earnings distributed to its shareholders. It serves as a tangible reward for shareholders’ investment in the company. If you are managing your own finances or are new to the stock market, understanding dividends and their types is crucial.

A company distributes payments to shareholders through dividends in the form of either cash or extra shares. The company board of directors gives approval for these payments, which come from the organisation's profit reserves. 

Companies distribute their dividends through predefined schedules, which can be either quarterly or annually. Companies which maintain steady earnings and strong financial stability tend to provide these payments.

How dividends work provides insight into how shareholders benefit from a company's profitability. The process involves several key steps:

1. Decision: When a company receives extra income, the board decides whether to share it with shareholders as dividends 

2. Declaration: The company's board of directors announces the dividend. They specify the amount and the dates associated with its distribution 

3. Ex-Dividend Date: This is the cut-off date to be eligible for the dividend. You must own the stock before this date to receive the dividend 

4. Record Date: The company reviews its records to identify shareholders eligible for the dividend 

5. Payment Date: The company distributes the dividend to shareholders on this date

The Dividend Payout Ratio is a crucial metric, calculated as:

Dividend Payout Ratio = (Dividend per Share / Net Income) × 100

This ratio indicates the proportion of earnings a company returns to shareholders as dividends.

Companies may choose to distribute dividends for several reasons:

• Rewarding Shareholders: Dividends provide a direct return on investment, acknowledging shareholders' support. 

• Signalling Financial Health: Regular dividends indicate stable earnings and confidence in future profitability.

• Attracting Investors: They can make a company's stock more appealing to those seeking regular income.

• Efficient Capital Allocation: It can be a strategic decision with limited reinvestment opportunities.

When a company announces a dividend, its stock price typically rises as it signals strong financial health and rewards to shareholders. However, on the ex-dividend date, the stock price usually drops by approximately the dividend amount, reflecting the payout adjustment.

Dividends are usually calculated on a per-share basis. For example, if a company declares ₹5 dividend per share and you own 100 shares, you receive ₹500. Companies may also express dividends as a percentage of face value (e.g., 50% on ₹10 face value equals ₹5 per share).

In India, dividends are a part of taxable income for shareholders. Key points include:

• Taxation: Taxes apply on dividends as per your applicable income tax slab rates.

• TDS (Tax Deducted at Source): As per the latest provisions, if the total dividend income exceeds ₹10,000 in a financial year, TDS is applicable at 10%. 

• Exemptions: No TDS applies if the total dividend income does not exceed ₹10,000 in a financial year.
  

Understanding the timeline of dividend distribution is crucial:

• Declaration Date: The date on which the company announces the dividend 

• Record Date: The cut-off date on which a company identifies the shareholders eligible to receive the dividend 

• Ex-Dividend Date: It comes a day or two before the record date. You must purchase the stock before this date to be eligible 

• Payment Date: The date on which the dividend is actually paid to shareholders  

Being aware of these dates ensures that you receive the dividends you are entitled to.

Dividend stocks consist of company shares which regularly distribute their earnings to investors as dividend payments. The companies that pay dividends usually belong to established firms which maintain stable earnings throughout their history. 

You can generate dependable revenue through dividend stocks.  A dividend stock exists primarily in the utility industry, the consumer goods industry, and the financial sector.

Based on their payment patterns and characteristics, you can categorise the types of dividend stocks. These include: 

• Regular Dividend Stocks

These are companies that have a consistent track record of paying dividends at regular intervals. They are often favoured by investors seeking predictable income.

• High-Yield Dividend Stocks

These stocks offer a higher dividend yield relative to their share price. You can calculate the Dividend Yield as:

Dividend Yield = (Annual Dividend per Share / Current share price

High-yield stocks can provide substantial income but may also carry higher risk.

• Dividend Growth Stocks

These companies not only distribute dividends but also consistently raise the amount paid over time. Such gradual increases in payouts can help you maintain your purchasing power during inflation. 

• Special Dividend Stocks

Occasionally, companies may issue one-time dividends, known as special dividends. They often result from extraordinary earnings or asset sales, and companies pay them on common stock.

• Preferred Dividend Stocks

They offer fixed dividend payments and have priority over common stocks in dividend distribution. You earn them on shares and function similarly to bonds.

Dividend Payout Ratio measures the percentage of a company’s net earnings distributed to shareholders as dividends. It reflects how much profit the company returns to investors versus how much it retains for growth.

Dividend Yield, on the other hand, shows the return on investment from dividends alone, calculated as the annual dividend per share divided by the stock’s current market price. While the payout ratio indicates dividend sustainability, the yield helps investors compare income potential across stocks.

You must consult the latest tax guidelines or a tax professional for accurate and personalised information.

When assessing dividend stocks, consider the following factors:

• Dividend Payout Ratio: Indicates the sustainability of dividend payments 

• Earnings Stability: Companies with consistent earnings are more likely to maintain dividend payments 

• Dividend History: A track record of regular and increasing dividends can be a positive sign 

• Free Cash Flow: Sufficient cash flow is necessary to support ongoing dividend payments 

• Industry Trends: Certain industries are more conducive to stable dividend payments 

Evaluating these factors can help investors make informed decisions regarding dividend stocks.

Dividend stocks are often seen as a safe and reliable investment option. However, several misconceptions can lead to unrealistic expectations or poor investment decisions. Here are some top myths busted:  

• Guaranteed Dividends: Companies are not obligated to pay dividends. It may reduce or eliminate them based on financial performance. 

• High Yield Equals High Return: A high dividend yield may indicate a declining stock price or potential financial issues. 

• Dividend Investment is Tax-efficient: In reality, taxes on dividends apply at your applicable tax rate. Dividends are subject to TDS 10% and may yield lower overall returns than growth stocks. 

• Dividends Eliminate the Need to Diversify: Relying only on dividends can limit your portfolio’s growth potential. While they offer steady income, ignoring high-growth investments may lead to missed opportunities.  

Understanding these misconceptions can lead to more realistic expectations and better investment decisions.

Dividends play a significant role in the investment landscape. They offer a means for companies to share profits with shareholders. By knowing the various types of dividends and dividend-paying stocks, you can better navigate the stock market and make informed decisions. 

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.