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What are a dividend and the types of dividends paid?

What are a dividend and the types of dividends paid?

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A dividend is a share in the profit of the company that is distributed to the stock investors. The dividend is a way for the shareholders to participate in the growth of the company. It is mostly paid in cash and is separate from the growth in price that a stock experiences. Dividend per share is the sum of the total dividend that a company distributes in a year divided by the total number of average shares the company holds.

When a company finishes paying its creditors it can use the remaining or some of the remaining profits to reward its shareholders as dividends. It may skip the dividend when it faces a shortage of cash. There are other companies that don’t pay any dividends and utilize the surplus cash for growth.

Investors can increase their wealth if they invest in dividend-paying stocks carefully. The dividend does matter for long-term investors and for retirees. it is all the more important when they are partly dependent on the dividend income to run their household.  For the youngsters as they may not need the dividend income, the best thing they can do is to reinvest it. Dividend stocks are better than bonds as they provide dividends along with stock price appreciation.

Why do some companies pay dividends and others don’t pay dividends?

A dividend-paying company denotes mostly that it is in a good financial position and the dividend attracts investors if it is high. The companies paying good dividends are generally stable and of high quality. These companies have become mature over a period of time, require less capital reinvestment, and the dividends are distributed after the operating expenses are covered.

When a company is young and growing it requires capital to grow at a quicker pace.  So it may decide to skip the dividend and reinvest the money in the growth of the company. This would result in an increase in the price of the stock if the company is growing very fast and that will ultimately benefit the shareholders.

How to choose the best dividend-paying stocks-

Investing in good dividend-yielding stocks offers protection from inflation. Investors should select companies that have earnings growth expectations between 7% & 15%. The growth of the company should be consistent and there should be a regular cash flow to pay the dividend. A company with a consistent track record of paying dividends for the past five years can be considered. Companies with high debt can be avoided as they would require the money to clear off the debt and may not be inclined to pay the dividend.

Record date and Ex-dividend date-

The record date is the cut-off date that shows which shareholders are eligible to receive dividends. The record date is needed to ascertain who the company’s shareholders are as of the date who are entitled to receive the dividend. It is important as the shareholders of a traded company are continuously changing.

The time or the day when the buyer of a share of a company is not eligible for the dividend payout is called the ex-dividend date.

Let’s say the company XYZ has declared a dividend of Rs. 2 payable on August 4, to the shareholders as of the record date of July 15. Here the record date is July 15 and the ex-dividend date is one business day before the record date which is July 14.

The payment date is the date when the dividend is credited to the investors’ account.

Types of Dividends-

The two types of dividends that a company rewards its shareholders are-

  • Special dividend-

A special dividend is a non-recurring type of dividend that is generally distributed as cash to the shareholders and is generally larger than the normal dividend. It may be given due to events like asset sales or any other event that has generated a windfall profit or it may even be due to substantial profits accumulated over the years that may not be required in the near term.

  • Preferred dividend-

A preferred dividend is paid on the company’s preferred shares. When a company is not able to pay all the dividends claims, the preferred shares take priority over the dividends that are paid on common stocks.

Other than the two types of dividends mentioned above there are other dividends namely-

  • Cash-

A cash dividend is the distribution of money to the shareholders directly in the form of cash and is distributed from the current earnings or the accumulated profits. It can be sent electronically or in the form of a cheque.

  • Stock-

Stock dividend is the percentage increase in the number of stocks of a company. It depends on the number of shares an investor holds in a company. Suppose an investor holds 100 shares in a company and the company announces a 20% dividend the investor will have 120 shares in all.

  • Property dividend-

A property dividend is issued in place of cash. They have a monetary value even though it is a non-monetary type of dividend. The shareholder may hold the asset for further long-term capital gains.

  • Hybrid dividend-

A hybrid dividend is a type of dividend that involves a cash payout as well as a stock payout.

Dividend by Mutual Funds and ETFs-

Mutual funds and ETFs also distribute dividends to their shareholders as they hold dividend-paying stocks. When you have a mutual fund or an ETF you will be paid dividends depending on the number of units you hold and the company’s representation in the fund.

Dividend payout ratio and the dividend yield-

Dividend payout ratio-

The dividend payout ratio is the ratio of the number of dividends paid to the shareholders as compared to the net income of the company. It can be calculated as the yearly dividend per share divided by the earnings per share (EPS).

Dividend yield-

A dividend yield is the percentage of the company’s share price that it pays in dividends every year.

Dividend yield= Annual dividend per share/ Current share price.

So how much should an investor invest in dividend stocks? This would depend on the risk tolerance of the investor, the time frame for which they invest, and the immediate income needs of the person. The dividend stocks are subject to market and company-specific risk. Persons who wish to make investments in dividend-yielding stocks should undertake a thorough study of the high dividend-paying stocks, make a list, and select the best.

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