Every investor has a common goal – to make money from his or her investment. There are two routes through which this can be achieved
- Capital Appreciation
- Making money from the dividend payout
For capital appreciation, the fundamental is simple. Buy when low and sell when high. The difference is the profits. Most investors aggressively follow this principle and are always on the lookout for good stocks at a cheap valuation.
However, there is another effective way to make money from shares which are often overlooked by investors especially the uninitiated. It is through Dividends. Read on to know more about how to make money from dividends.
Dividend - Meaning
A dividend is the amount of money paid to the shareholders from the earnings (including reserves) of the company. It is a reward given to you, as a shareholder for investing your money in the company. It is a way to:
- Return a portion of the profits to the shareholders
- Attract more investors
- Show financial strength
- Create more demand for their stock which can have a positive impact on the market value of the shares.
There is no legal obligation for companies to issue a dividend. Newly started companies or those with a high growth rate seldom pay out dividends. This is because they need to reinvest their profits for research, growth or expansion. However, established companies offer a regular payout to reward their shareholders.
When the dividend is announced, it decides a record date and all registered stockholders (as on the record date) are eligible to receive the dividend payout in proportion to the number of shares held by them.
Frequency of dividend payout
Usually, companies declare dividends twice in a year i.e. Interim Dividend and Final Dividend. However, this is purely at the discretion of the company and is not subject to any guidelines or rules.
Types of dividend:
A dividend is a proportion of retained earnings that is paid out to the stockholders. There are five types of dividend payout mechanism:
This is the most popular and commonly used dividend type. Cash dividends are usually done through electronic transfers to the investor’s bank accounts or through cheque payments. For example, ABC Co.’s Board of Directors declared a cash dividend of Rs. 3 per share for the 2 lakh outstanding shares, to be paid on 30th Sept. Ms. A holds 2,000 shares of ABC Co. She would receive Rs 6,000 as dividend income in her bank account on the said date.
Stock dividends are paid to the shareholders by giving them additional new shares of the company. This allotment is done at zero consideration. The issue of stock dividends is done on a pro-rata basis. In case the company issues additional stock (as a dividend) which is less than 1/4th of the number of existing outstanding shares, it is treated as a stock dividend. If the new issue is of a greater proportion (i.e. more than 1/4th), then it is referred to as a stock split. The fair value of the new stock issued as a dividend is calculated basis the fair market value on the date of dividend declaration.
Dividend payouts done through promissory notes are scrip dividends. At certain times, companies may have a cash crunch or insufficient earnings for them to pay out dividends. In such scenarios, they may issue scrip dividends to the shareholders. The shareholders are given a note or scrip that promises payment at a certain future date. Usually, these promissory notes come with a definite maturity date. They may or may not be interest bearing.
Bond dividends and scrip dividend are similar in principle. They both indicate a dividend payout at a deferred future date. In the case of a bond dividend, the company makes a promise to pay out the dividend at a later date in the future. To that effect, it issues bonds to the shareholders instead of cash. Bonds used as a way to pay dividends always come with interest. Usually, bond dividends have a longer maturity date as compared to scrip dividends.
Some companies pay the dividend in the form of assets (excluding cash). For instance, a company may distribute its superfluous assets or own products as dividends. This form of dividend payment is not very common in India.
Making money from dividend
Most investors make the cardinal mistake of taking the dividend yield as an absolute value. They feel that a yield of 2% or 3% is too less for them to make a good amount of money from dividends.
However, as a prudent investor, you must keep the following points in mind:
1. Growth with time
An established or fundamentally robust company will keep on increasing the dividend payouts with time. Also, while the dividends will increase, your purchase cost stays constant throughout the holding period.
So, if you calculate the dividend yield, the numerator (annual dividend) will keep on increasing while the denominator (purchase cost) remains unchanged. In short, a higher yield in the future.
Expert Tip: Making money from dividends is like a test match. You need to play consistently in the long run. You should not treat it as a 20-20 match.
It is important to understand the tax liabilities for income from dividends. If the dividend is paid by an Indian company, it is exempt from tax until such income does not exceed Rs. 10 Lakhs. Dividend income above 10 Lakhs is subject to a 10% tax.
However, dividends received from a foreign company is added under the category “Income from other sources” and taxed as per slab.
Expert Tip: Hence, it is important to choose the right stock to get more net income in hand.
Top #5 Things to consider before dividend investing
Making money from dividends needs careful evaluation of several factors. These include:
1. Yield Percentage:
The dividend yield of the stock at the time of investing. It is important to check the yield percentage and not just the dividend per share.
2. Profit Growth Rate:
The growth rate of the company’s bottom and top line. The profit growth rate can be useful in projecting future dividend earnings.
3. Financial Health of the Company:
The overall health of the company. You should check the balance sheet to find the amount (and type) of debt. Too much debt or continuous fall in sales revenue may pose risk to dividend income in the future.
4. Dividend History:
Remember that paying a dividend is not an obligation. Companies are free to reduce or stop these payouts. Hence, analyse the dividend history of the company under consideration.
5. Tax Rules:
Current tax rules applicable to dividend income.
If you feel that you are not able to decide the highest paying dividend stocks or need help in choosing the right stock for you, you can always reach out to experts like IndiaNivesh. Their in-depth understanding of the Indian markets, extensive research, and experienced team ensures that each customer can make the right choice as per their needs. They regularly come out with useful reference material which highlights the top dividend-paying stocks. IndiaNivesh offers financial solutions in numerous domains – Mutual Funds, Broking, IPOs, Insurance, Derivatives, PMS, Investment Banking, Wealth Management, and Strategic Investments. Get in touch with the experts today!
Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing