As discussed, shares comprise a certain portion of an organization. Several profit-making companies listed on the share market share their profits among shareholders, which is the primary objective of paying dividends. Companies distribute a small component of their profits as dividends to the investors. This becomes an important source of earnings for investors who stay involved in the share market for a longer period of time.
Because dividends are a minor portion of company profits that are returned to the investors, they provide additional incentive for individuals to hold on to their stocks even if the company is not growing at high rates. This is an important share market basic, which all investors must remember.
Companies utilize dividends to share the annual profits directly with the shareholders. Generally, it is paid as cash; the organization pays a small percentage of the earned profits to every shareholder. Sometimes, this profit share could be in the form of offering additional stocks to the investors.
Important Facts to Know about Dividends
Periodic Payments: Most companies pay an annual dividend based on the total profits made during the year. In certain instances, organizations may pay quarterly dividends or special one-time dividends if exceptional profits have been earned through unique events.
Taxable: Investors need to bear in mind that income earned from dividends is taxable as per the Income Tax Act, 1961. An accountant should ideally be consultant for clarifications and more details on this.
Types of Dividends
Companies can either pay fixed rate, referred to as preferred dividends, or they can pay variable dividends based on the earnings, known as common dividends.
Investors should remember one thing about share market investment — companies are not obliged to make these payments by any regulatory guidelines. However, preferred shareholders are more likely to receive these pay-outs, unless the companies are going through exceptional financial difficulties.
Dates to Remember
Declaration Date: This is the date when the company determines the payment date for the dividend, the ex-dividend rate, and the dividend amount.
Record Date: The companies compile the list of all the shareholders as on the record date. All these investors are eligible to receive the declared dividends.
Ex-Dividend Date: This is often a few days before the record date. The primary objective of this date is to ensure pending transactions, if any, are completed prior to the record date. Any investor who does not own company shares before the ex-dividend date will be ineligible to receive the dividends for the said period.
Benefits of Dividends
For Companies: Organizations on the share market pay dividends to retain investors by keeping them happy. It is often perceived that dividend-paying organizations have progressed from the growth stage, which means they cannot keep pace with the rate of growth expected by the markets. Organizations that do not reinvest their profits to grow their companies pay dividends to shareholders. Regular dividends make the stock appealing to investors, which, in turn, helps in increasing the price of the share.
For Investors: Dividends provide investors a stable return on their investments, which is low risk. Individuals who are risk-averse can be assured of investing their money in stable companies with low growth but with almost no risk of a fall in share prices, which can then risk their capital investments. In addition, as the organizations continue to grow, the dividends increase, which raises the value of the stock for the investors.
Investors need to bear in mind that bigger dividends do not always mean better. It is generally seen that companies paying high dividends are unable to sustain these rates in the longer period. Thorough research and exercising caution while choosing dividend-paying companies will help sustain periodic returns on investments in the share market.