Being a responsible investor does necessary means discovering various types of stocks in the share market according to your spending and risk-taking ability with your return requirements. With said that, return requirements vary from age to age and income class. A young investor might look for speculation whereas old aged investor might look for regular return from investment.
Dividend stocks refer to the stock of publicly listed companies that pay out regular dividends to their shareholders. These stocks are generally associated with large-cap companies having much credibility and profit margins with a good image in the market. Large-cap companies in India are tagged on the basis of valuation, which is having a market capitalisation of Rs. 20,000 crore or above.
Dividend stocks come under less risky categories as issued by large companies, they have mostly stable profits and operational efficiency even in downtrends and therefore maintain dividend payouts for satisfactory investor sentiments.
One such example could be Coal India Ltd. a company working in the coal extraction segment that has been a market leader with a good dividend track report and has consistently declared dividends for the last 5 years.
For the year ending March 2021, Coal India has declared an equity dividend of 160.00% amounting to Rs. 16 per share.
What Are Dividend Stocks?
If you are a shareholder you are most likely to seek a share in the company’s profit, this share that you get is often referred to as a dividend.
Once the company evaluates its net profit , board of directors will decide the part of profit to be retained for growth and the rest part is distributed as dividend to the shareholders in proportion to their holdings.
Stock value of the company and its market capitalisation also influences the dividend income at the time of disbursal. The dividend stocks are mostly backed by dividends to their shareholders by paying out part of the profit to eligible investors. This can be considered as a reward for owning a share.
Calculation Of Dividends On Dividend Stocks
Dividend income per share is calculated by applying the dividend payout ratio of a dividend stock company.
Dividend per share = earnings per share x dividend payout ratio
This determines the amount that each shareholder would be getting as a reward for one share held by them and thus helping them make future decisions according to current payouts.
Knowing the level of dividends, one can assess the retained capital and therefore get insights into future goals for the growth of the company.
Dividend payout ratio if higher indicates less sustainability of dividends.
Taking an example of market leader Coal India, the dividend payout ratio as of September 2021 is 0.72.
A dividend is not treated as an expense , instead it is considered to be an allocation of a company’s retained earnings.
Affecting the total equity of the company, dividend stock does make a significant impact on the financial statements of the company. Major changes occur in the balance sheet and cash flow statement as cash and retained earnings are reduced from the calculations.
Companies Likely To Have Dividend Stocks
As discussed above , stable and big companies are most common to issue dividend stocks, some major industries having large-cap dividend-paying companies are:-
- Bank and financial companies
- Oil, gas and petroleum industries
- Health and pharmaceutical
- Real estate
- Utilities – Electricity, water etc.
These types of companies generally possess large capital and function at wholesale segments that make them profitable and stable, this also attracts investors to join the shareholdings.
Like Coal India is a big industrial company with a dividend yield of 7.5% remains attractively valued. Majorly startups and technology sector companies do not enter into dividend stocks as the initial stages are roller coaster rides for earnings and stability.
Relation Between Share Price And Dividend
Simple events of uptrend and downtrend do take place due to dividend announcements.
Dividend payout means a permanent reduction of total payment from the company’s account and therefore affecting share price valuations .
First of all, when a dividend is announced, the share price climbs up by the same amount that of the dividend declared. This is typical because the existing shareholders would sell only if they get the benefit of the same amount and the new participants would like to buy before the ex-dividend date to be entitled shareholder and receive dividends.
You would know about important days in further sections.
Not just that increased amount, but the market generally suspects additional increase in prices due to investor sentiments. Then in the next part when all the eligible shareholders are declared, the market opening session again adjusts the prices, and the current price decreases by the amount of dividend declared.
Let us understand this mechanism with a hypothetical example :-
A company ABC ltd. announces a dividend of Rs.5 per share having an existing share price of Rs.40. By the adjustments, the new share price stands at Rs.45. Expecting an increase in overall value suppose the price rises to Rs.47. Now the day after the ex-dividend date, the market will open with Rs.42 for each stock of this company. This is where it compensates for the amount of increased price due to dividends.
Coal India Ltd. share price before the ex-dividend date (2nd September 2021) was Rs.144.20 whereas a day after the ex-dividend the price closed at Rs.141.60.
Types Of Dividend
There are a variety of options via which a company can deliver the dividend payment to entitled shareholders, broadly classified as below mentioned categories:-
Special dividend
This is announced when a company has some accumulated profits and surplus cash in hand with no motive of usage. This surplus is given out as dividends occasionally and is not regular in nature. Dividend stocks do not come under this category as their main feature is regular dividend payouts.
Preferred dividend
Such a dividend is issued to the preferred stock owners and usually accrues a fixed amount that is paid quarterly. This serves as an example of dividend stocks as the regularity of income is sustained. The company having regular profits in hand are most likely to give out a dividend to sustain their shareholders.
The ways through which dividends are paid out are as follows :-
Cash
Simple meaning of a cash transaction is transferring the cash amount of entitled dividend to the shareholder’s account. This can be bank transfers or cheque based facilities. More often the use of cash-based transactions is provided.
Asset
Some companies may reward their shareholders in the form of physical assets, investment securities and real estate. This method has its implications but is a rarely adopted method for dividend payouts.
Stock
In this type of dividend distribution, the existing shareholders get new shares of the company as dividends. The new issued shares are on a pro-rata basis depending upon the existing number of shareholdings.
Taxation Related To Dividend Stocks
Earlier than 2020, the tax for dividend distribution was imposed on dividend declaring companies. The new law passed as “The finance act,2020” has shifted the burden of tax on dividend income on investors. Notably, it has become important for you as an investor of dividend stocks to know the tax implications before you choose the stock type.
Now the investors would be liable for paying on dividend income received by them. The new regulation gives a TDS (Tax Deducted at Source) window of 10% on dividend income which is greater than Rs. 5,000 (company deduces from the payout and then transact) . Once the transaction is paid into the investor’s account then that person is liable to pay tax on dividend income according to their income tax slab.
You are eligible for a tax reduction only if the invested money is generated from the loan. In that case, your taxable dividend income is deduced by not more than 20% of the entitled dividend income, this is basically to reduce the interest burden on loan.
These numbers might sound vague without actual practical so let us get into an example.
Suppose Mr. Anish is an investor in ABC.ltd company that has declared a dividend of Rs.7,000 to him. Also, Anish has invested via a loan, and he has to pay the interest income of Rs.2,500. Now in this case, as dividend income is more than Rs.5,000 , TDS of 10% would be deducted from the dividend and the company would transact Rs.6,300 to Mr. Anish. As the interest expense is Rs.2,500 , the deduction for taxable income corresponding to interest expense would be Rs.1,400 .
Capital Gains v/s Dividend Income
People generally confuse between capital gain and dividend income as both are treated as income from the investment but realising the true story of dividend stocks we can judge the difference between both.
Capital gains
When you purchase shares of a company on any day, in the stock market you would observe the changing prices of that share in minutes depending on trade volumes, and so if the price increases more than your purchased price you would see it as a profit. This gain can be availed by investors even by short selling.
This profit is called a capital gain only when it is realised that the liquidity of that extra income can only be used when you sell the share at an inflated price. Capital gains are regular or irregular or can even be negative, all depends on the market performance of the stock.
Dividend income
On the other hand, as discussed above, we know dividend income from dividend stocks is regular. The company payout dividend and it all depends on retained earnings and prospects.
During the past 13 years, the highest Trailing Annual Dividend Yield of Coal India was 15.49%. The lowest was 2.59%.
It is a reward but does not depend on market indices solely. Mostly availed by investors who stick to the stock for a longer time period. Also, an investor is lucky in case the dividend stock yields dividend and also has increased performance in the stock market, then both can go hand in hand.
Dates for Dividends Payout
The process of dividend payout comprises systematic proposal and execution with proper specifications to all shareholders.
Ex-dividend date
The date on which the dividend eligibility expires is called the ex-dividend date. This is an important date to find the eligibility of shareholders who are entitled to dividends. This means that any shareholder who buys the share on or after the ex-dividend date is not eligible for dividend income. The same goes for any shareholder who sells the stock before the ex-dividend date is not eligible for dividend payout.
Announcement date
This is the date where the company declares the dividend publicly, this happens after the successful nod from the board of directors as well as shareholders with voting rights. The company is responsible to declare every true aspect related to the stock and dividends to the public.
Record date
The record date is a day on which the company scrutinizes the eligibility of shareholders who are entitled to dividends on their stocks.
Payment date
The date when the actual dividend is paid out to shareholders is known as the payment date.
Using a real-life example of Coal India Ltd. which recently was found in talks due to dividend policy, the company announced its final dividend on 14th June 2021 with an ex-dividend date as 2nd September 2021. The declaration cited that the dividend is 35% as Rs.3.5 on each share.
Why To Choose Dividend Stocks ?
Choosing dividend stocks gives a safer option for stable investment as periodic returns are accessible even when the market is low. Also, a company that pays out regular dividends implies a good cash flow and a sustainable profit margin.
These stocks are majorly for investors that participate in the market for a longer time and play safe. Dividends stocks increase the trust and loyalty of shareholders towards the company and have full ability to show an uptrend in share prices further enhancing capital gains.
Tips To Choose Dividend Stocks
- Sustained and strong cash flow position with long term earning capacity of 5% to 15%.
- Low debt expense of the company is essential to expect dividend stock.
- The capital size of the company with sector trends and public image is an important factor to be kept in mind for choosing the best dividend stock picks.
- Try finding companies historical dividend scenarios and expectations.
Reinvesting Dividend Income
If you do not wish to consume the dividend income, it is better to gain on it as well. As rightly said no income should be kept ideal. This also implies dividend income, in this case, you can use the dividend income to increase your stakes.
The simplest of all is a dividend reinvestment plan that you can apply to the company. This plan facilitates automatic reinvestment of your dividend, that is the company will buy shares for the amount of dividend automatically and add them into your account. This serves as a better option to use your dividend income and adds to your portfolio.
Top 5 Indian Dividend Stocks As Of November 2021
- Coal India with a dividend yield of 10.26% at a valuation of Rs.96,076.93 crore.
- IOCL (Indian Oil Corporation) with a yield of 9.92%.
- REC Ltd. has a dividend yield of 9.77%.
- Power Finance Corporation ltd. yielding 8.40%.
- HPCL (Hindustan Petroleum Corporation Ltd.) has yield 7.53%.
Conclusion
Dividend stocks are safer for regular returns and are advised for investors whose main purpose of investment is to generate periodic income besides the share price appreciation. Just like any other investor, a dividend stock investor must scrutinise all the backdrops and commanding factors while entering into shareholdings.
The basic tax implications are also to be kept in mind. If you are an investor who is looking for trading and short selling, then dividend stock serves less of your purpose than capital gains. Long term commitment to dividend stocks gives out more beneficial returns.
Investors are not biased towards methods of dividend distribution but are more inclined towards cash dividends that give them chance to consume or invest their dividend income according to their will.
Read More – How To Invest In Blue-Chip Stocks
