Dividends can be explained as a payment made by a company or an organization to their shareholders, usually in cash, and usually, as a distribution of profits. What does “usually in cash” mean? Well, some companies offer the option to choose a stock dividend.
Often, this is a gesture of reward paid by the public listed companies to their respective stockholders for showing trust and investing their money into the venture.
The frequency of payments differs depending on the company and its policies. Some companies pay dividends annually, others twice per year, and many even quarterly.
Now when we say “usually as a distribution of profits”. Mostly this is measured using a metric called as Dividend Payout Ratio which is dividends as a percentage of actual or percentage net income. This Dividend Payout Ratio varies by company, by industry, and is strongly dependent on the stage of the business cycle the company is in. Many companies may continue to pay dividends or increase the dividends even if profits are getting lower.
Along with public listed companies, various mutual funds and exchange traded funds also pay dividends.
The three important dates regarding to the dividends you need to know are:
- Ex-dividend date where dividend eligibility expires.
- Record Date are Cut-off dates where shareholders eligible for dividends are determined.
- Payment Date is the day when the payments of the dividends are to be issued.
Short-term impact of dividends on the stock price:
- In most cases, the share price rises from the day when the dividends are declared to the ex-dividend date. As temporary ownership of shares till the ex-dividend date will assure dividends.
- As the ex-dividend date passes, many owners of the shares sell the stock as they meet eligibility criteria to receive dividends.
Often, the above strategy is used by traders and not investors to gain quick money. But always remember, such a strategy comes at great risk as short-term price swings (not in our favor) can be very risky.
Dividend Stocks v/s Growth Stocks:
A company decides to pay a dividend when they have earned a fair share profit from the past financial year. So when a company is constantly earning good profits in its previous years and there is no debt to pay for the company, also there is no plan to expand or grow, that is when the company management can decide to pay the dividend to the investors. The stocks of such companies are called Dividend Stocks.
Now, in a different scenario what if a company decides to first eliminate or reduce the debts and also invest the remaining amount of the profits into the future growth of the company? There will be no or little money left to reward the shareholders. Should this upset an investor? No! Rather this indicates the company is ambitious to grow and if it does, so will its stock price. In most cases, the stock price increase is much higher than dividend paying companies. The stocks of such companies are called Growth Stocks.
Some basic indications based on dividend:
- When the company declares high value dividends it indicates that the company is doing well and generated good profits, but it also indicates that the company has got no plans and projects for the future where they can invest their profits in and generate better returns for their stockholders in the future. This can be a crucial viewpoint for the stockholders who believe their stocks are their wealth and will generate good returns in the future.
- When a company has a long history of paying high value dividends and suddenly shows a reduction in the dividend value that is a strong signal that the company might be in trouble with financial issues. One needs to carry research here about the company’s future plans and projects which will give you the clarity to move forward with that stock.
- During the economic downturn, if a company is able to generate lower than regular profits and still declares dividend payoffs, it is highly likely that this company may not be one of the worst companies to invest in at any point of time.
- Companies that have never declared any dividends historically, nor have any plans of expansion mentioned during their public disclosures can be avoided to avoid heavy losses when least expected.
Some quick guidance on dividends:
- Re-investing your dividends can pay off in the long run.
- Re-investing dividends may help you build wealth, but may not be the right choice for every investor.
- If company aspects are good enough and could continue to be good enough, then one should never try to sell the bonus shares received in form of dividends.
Meet the Author
A software engineer, trying to steer his way to financial freedom. In my journey, I come across many resources and experiences. I wish to journal every such experience here on my blog. I invest in stocks of NSE-BSE and also invest in mutual funds. All of the information I share here is strictly to educate my blog readers and help them start or manage their own journey towards financial freedom.Learn more
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