Whether you are an experienced investor or a newcomer, you probably have heard about dividends numerous times. In financial terms, these are payments publicly traded companies make to shareholders in the form of cash or additional shares, also known as stock dividends. Investing in the best dividend paying stocks is an excellent way to ensure that you can create a regular and steady income stream. There are several reasons investors look to dividend stocks, such as that most of them pay out quarterly, which can provide relatively reliable income.
In this blog, we will help you understand dividend meaning, how it works, its calculation with an example, and tax implications on individuals.
Table of Contents
What is a Dividend?
A dividend is a portion of a company’s profits that it pays to its shareholders. You must be thinking, how? In simple terms, when you buy shares from a company, you become a part-owner of it. So, if the company is earning well, it may decide to give a portion of its earnings to its shareholders as dividends. This is one of the ways you can make money from that ownership.
Companies are considered more stable and financially sound if they pay dividends. Records show that dividend stocks have served as a protector during market fluctuations. In case the company does not generate any revenue or decides to reinvest its profit, it may not pay dividends. Dividends also carry certain risks, but despite that, they can provide consistent earnings for shareholders.
Why Do Companies Pay Dividends?
A company pays dividends to its shareholders to maintain its investors’ trust. The more dividends a company offers to its shareholders, it indicates the company is performing well and generating good revenue. Generally, companies pay dividends quarterly, but they can also distribute them yearly or at any time they want.
Your dividend amount depends on how many shares you own and how well the company performs. But it depends on the company’s profitability and decisions made by its board of directors whether you will receive dividends or not.
How Dividends Work
Dividends are simply a way for companies to share a portion of their profit with shareholders. Understanding how this process works can help you make better decisions.
1. Company Earnings: When a company generates earnings, it can decide to plow those earnings back into the business or distribute them to its shareholders.
2. Declaration: Should the company opt to disburse dividends, the amount of the dividend, along with the schedule for when it will be paid, will be announced by the board of directors.
3. Payment: The dividends are paid to the shareholders on a specific date known as the “payment date.” The exact sum that a shareholder receives depends on the number of shares he or she owns.
Types of Dividends
Depending on a company’s financial strategy and structure, dividends are available in different forms. Here are some:
1. Cash Dividends: The most prevalent form, whereby shareholders are paid directly into their accounts.
2. Dividends in Stock: Rather than paying cash, the company gives shareholders additional shares, boosting the total number of shares they hold.
3. Property Dividends: Infrequently, a company may choose to distribute tangible assets or property instead of cash or stock.
4. Special Dividends: These constitute one-time disbursements to shareholders. When it has extra cash or has divested a part of its business.
5. Preferred Dividends: Holders who have invested in preferred stock receive this dividend. There is a fixed amount paid to the holder quarterly.
6. Interim Dividends: Before the final accounts preparation, the companies announce interim dividends. This is paid during every financial year in India.
Important Dividend Dates
An investor should keep all important dividend dates in mind. To help you out, here are some:
- Declaration Date: The date on which the dividend is declared by the company.
- Ex Dividend Date: A company sets a deadline to purchase a stock, allowing you to still be eligible to receive the dividend.
- Record Date: In this, an investor must be on the company’s books to receive a dividend. It is typically set after the day of the ex-dividend date, and the board of directors decides it.
- Payment Date: On this date, dividends are paid.
- Settlement Date: When a shareholder officially owns the stock after purchasing, or receives payment if they sell shares, that means the trade is finalised. That specific day is called the settlement date.
How do Dividends Affect Stock Prices?
Now, you might wonder how dividends, as extra income to shareholders, affect the stock price. If a company is paying its shareholders dividends, it means its financial health is good. Let’s understand with the help of some pointers how dividends affect stock prices.
1. Investors Favour Companies with Consistent Dividend Payments
Investors favour such companies that pay dividends regularly rather than other companies that often do not distribute dividends. Several established market leaders regularly and consistently circulate the profits that they generate to show their strength and improve the goodwill and brand value of the company. Such companies attract even more investors, creating more demand for the stock, leading to a rise in share price.
2. Dividend Announcements Can Boost Share Price
A company always announces publicly before distributing the dividend to its shareholders. In this announcement, they include important details such as the amount of dividend, the ex-dividend date, the date of record, and the dividend credit date, i.e., the day on which the dividend is likely to be credited to the company’s equity shareholders.
But the question is, how does the dividend declared affect the share price of the company? The public declaration has the chance to positively affect the public’s sentiment for the high dividend yield stocks of the company, which can lead to an increase in the purchase of stock, consequently increasing the share price. Further, a few investors invest their money in stocks for a short period just to receive the dividend announced by the company. This move can also increase the price of the stock.
3. Ex-Dividend Date Can Lead to Drop in Share Price
The company corrects its share price automatically on the ex-dividend date in case the share price rises when the company declares the dividend. They do so as any new investor automatically becomes ineligible to receive dividends of the company’s stock on or after the ex-dividend date.
New investors might not be ready to pay a huge premium for the shares as they are not eligible to receive dividends. Thus, they would begin mentioning lower prices for the shares, compelling sellers to demand lower prices. This can negatively impact the company’s stock price.
Importance of Dividends to Investors
1. Generating Income
For many investors, particularly those who count on their investments to pay the bills, dividends provide a dependable income stream. They pay out a portion of their profit to shareholders, usually four times a year. In contrast, corporations that reinvest earnings for growth in the business often don’t pay dividends.
2. Return on Investment
They provide an opportunity to obtain a return on investment, even if the stock price stays the same. It is best to choose stocks that pay dividends to generate additional income.
3. Financial Health Indicator
Paying dividends consistently shows that a company is financially stable and has a strong belief in the near-future earnings growth. Companies that are doing well generally don’t pay out cash to shareholders; they reinvest it to fuel growth.
4. Reinvestment Opportunities
Shareholders can use dividends to purchase additional shares, which can have a compounding effect on their returns over time.
How to Calculate Dividends
You can easily calculate a dividend by using the dividend payout ratio method. For calculating the dividend payout ratio formula is as follows:
Dividend Payout Ratio = Total Dividends Paid / Total Net Income
Remember, for companies that don’t provide dividends to their shareholder, their dividend payout ratio is 0%. Also, if a company pays the total net income as dividends, it has a 100% dividend payout ratio.
Example of dividend payout ratio: Suppose a company pays out ₹600,000 in dividends and has a net income of ₹2,000,000, the dividend payout ratio would be ₹600,000 / ₹2,000,000 = 0.3 or 30%.
Formula for Dividend Per Share
Now, suppose you want to calculate the dividend per share, which represents the amount of dividends allocated by a company for each outstanding share of its stock. It helps in estimating the amount received per share from a particular company, making it an important measure for investors.
Here is the formula:
Dividend Per Share (DPS) = Total Dividend Paid / Number of Shares Outstanding
Dividend Per Share Calculation Example
Let’s understand this with the help of an example. You invested in a company that pays a dividend annually of ₹1,10,000 and has 20,000 shares outstanding.
Using the DPS formula:
DPS = ₹1,10,000 ÷ 20,000 = ₹5.5 per share
The DPS of ₹5.5 per share shows how much dividend income a particular share of the company’s stock has been allocated.
Formula for Retention Ratio
There is another ratio that investors should consider while calculating dividends: the retention ratio. It shows how much a company’s earnings are kept for reinvestment in comparison with dividends distributed to shareholders.
Retention Ratio = (Net Income - Dividends) / Net Income
A high retention ratio may indicate that the company is choosing to reinvest its earnings for growth and expansion rather than distributing them to shareholders.
Key Differences Between Dividend Payout Ratio and Dividend Yield
The following table highlights the difference between the dividend payout ratio and the dividend yield:
| Point of Distinction |
Dividend Payout Ratio |
Dividend Yield |
| Focus |
The ratio focuses on the part of earnings distributed as dividends. |
It focuses on the annual dividend income a company pays out relative to the stock price. |
| Stock Price Impact |
It is more dependent on the earnings and dividend decisions of a company, and is less affected by stock price changes. |
It can be affected by stock price changes; a rise in stock price can decrease the dividend yield. |
| Investor’s Viewpoint |
To evaluate the sustainability and risk of dividend payments, this ratio is important for investors. |
It is an important measure for investors looking for high immediate returns from dividends. |
| Risk Assessment |
If a company’s earnings are unstable, high dividend payout ratios might indicate potential issues with dividend payments in the future. |
High dividend yields might signal risks due to a drop in stock price. |
Factors Affecting a Company’s Decision to Pay Dividends
Various factors that affect the dividend decision of a company. Some of which are as follows:
1. Revenue Generated
A company’s current and last year’s profits are distributed among its shareholders as dividends. So, if the revenue is more, dividends will also be great, and vice versa.
2. Steady Profits
A company that generates stable revenue every year and is capable of declaring a higher dividend as compared to those companies that do not have such stability in profits.
3. Future Growth Opportunities
When a company is working on a new project, it prefers to retain more money from its earnings to finance. So, companies that do not have any growth plan shortly, declare more dividends than those that have growth opportunities shortly.
4. Position of Cash Flow
The amount of dividends paid is connected to the cash outflow. There might be a chance that the company is profitable, but it may have a shortage of cash. The company still might pay more dividends if it has surplus cash, but in case the company is facing a shortage of cash, it can declare a low dividend amount.
5. Taxation Regulations
The government’s tax regulations also play a key role in the rate of dividends a shareholder receives. Dividend income is taxable in the hands of the shareholder at the applicable slab rate. The shareholders prefer higher dividends, but the companies have the power to make the dividend decision.
6. Share Price Movement
The dividend yield and the share’s market value are directly related to each other. When a company decides to pay a higher rate of dividends, it has a positive impact on the market price of the shares. And, the opposite reaction is received when a low rate of dividends is announced. So, while deciding the rate of dividend, a company’s management should consider the after-effect on the price of equity shares.
What are Dividend Stocks?
Several publicly listed companies regularly distribute dividends to their shareholders from a portion of their earnings. The shares on which the shareholders receive dividends are dividend stocks. These are well-established companies and maintain a decent track record of distributing earnings to their shareholders.
Wondering what to consider for choosing good dividend paying stocks, the following points can help you to choose:
- Look for a company with a dividend payout ratio of 50% or more.
- Dividend yield is between 3% and 6%.
- Steady revenue and profit growth to ensure long-term dividend payouts.
- Look for a company with low debt, as high debt might lower dividends during a crisis.
- Prefer to invest in a company with low capital expenditure (CAPEX), as high CAPEX can reduce dividend payouts.
- Estimate the fair value of the stock using the dividend discount model (DDM) to know whether the stock is undervalued, overvalued, or fairly priced.
Finally, check online and compare the top 10 dividend paying stocks India, in which you can invest to achieve high dividends on your investment.
Types of Dividend-Paying Companies in India
Dividend-paying companies come in different categories, depending on their financial stability, strategy, and industry. Here are some of them:
1. Blue-Chip Companies: These companies often pay dividends because they are mature and profitable. Examples of the best dividend stocks in India are: TCS, HUL (India), Infosys, etc.
2. Real Estate Investment Trusts (REITs): These companies must distribute at least 90% of their income to shareholders as dividends. Examples: Brookfield REIT, 360 ONE REIT, etc.
3. Utility Companies: Companies that provide essential services like water, natural gas, etc., and also offer regular dividends due to the consistent and predictable nature of their business. Example GAIL, NTPC, Tata Power, etc.
Dividend Tax Rate
| Category of Assessee |
Dividend Nature |
Rate of Tax |
| Resident |
Dividends received from a domestic company |
The normal rate of tax applicable to the assessee |
| Non-Resident Indian (NRI) |
Dividend on GDR of an Indian company/PSU (purchased in foreign currency) |
10% |
| NRI |
Dividend on shares of an Indian company (purchased in foreign currency) |
20% |
| NRI |
Any other dividend income |
20% |
| Foreign Portfolio Investor (FPI) |
Dividends on securities other than those under section 115AB |
20% |
| Investment Division of Offshore Banking Unit |
Dividends on securities other than those under section 115AB |
10% |
Tax on Dividend Income for Individuals
1. Dividends Received From Indian Companies:
TDS is deducted at 10% on dividends distributed, declared, or paid by Indian companies on or after April 1, 2020, as mandated by Section 194. It is only applied to resident individual shareholders when the overall dividend is more than Rs. 5,000 during the fiscal year. Also, there are exemptions to this rule; no TDS is deducted if dividends are paid to the LIC, GIC, or any other insurer that owns shares or holds full beneficial interest.
For example, if Aanchal received a dividend of Rs. 20,000 from an Indian company, XYZ, on April 20, 2024, the company would deduct Rs. 2,000 as TDS (10%), leaving Aanchal with Rs. 18,000. The TDS amount, which is deducted, will be adjusted against her total tax liability when filing the FY 24-25 income tax return.
2. Dividends from Foreign Companies:
Under Section 195, TDS of 20% is deducted for dividends payable to NRIs or foreign companies. Non-residents can reduce this rate under applicable double taxation avoidance agreements (DTAAs). By providing Form 10F, which is a declaration of beneficial ownership, and a certificate of tax residency to avail of the reduced rates. Non-residents can also claim back the TDS rate as a credit when filing an Indian tax return.
3. Taxation of Dividend Income from Mutual Funds:
From April 1, 2020, dividends offered by any mutual fund scheme are taxed in the hands of the investor. This means dividends received by investors are added to their taxable income and taxed at their respective income tax slab rates. Previously, dividends were tax-free in the hands of investors as the mutual fund houses paid the Dividend Distribution Tax (DDT) before paying dividends. The abolition of DDT has shifted the tax burden to investors under the classical system of taxation.
A resident individual receiving dividends can submit Form 15G to the company or mutual fund paying the dividend if his/her estimated annual income is below the exemption limit. Likewise, a senior citizen can submit Form 15H to the company paying the dividend if his/her estimated annual tax payable is zero.
The mutual fund house notifies the shareholder about the dividend declaration on their registered email address, and to claim dividend income without TDS, they need submission of Form 15G or Form 15H. Based on their financial objective, investors can select the growth or dividend option.
Dividends vs Capital Gains: Key Differences
Key differences between dividends and capital gains are as follows:
| Point of Distinction |
Dividends |
Capital Gains |
| Definition |
A dividend is an income received by shareholders from a company’s profits. |
Capital gain is the profit realized after selling a long-term asset. |
| Number of Beneficiaries |
The beneficiaries of dividends are usually a lot, it can be in thousands, depending on the number of shares issued. |
The beneficiaries of capital gains are generally a few, restricted to the owners and investors. |
| Tax Implication |
Typically, a dividend is charged at a flat rate (e.g., 10%, 15%). |
These are taxed differently depending on whether they are long-term or short-term. |
| Additional Payments |
Apart from regular dividends, investors can receive more in the form of bonus shares, splits, stock, etc. |
Nothing additional is offered apart from the changes in the gain. |
| Distribution of Earnings |
Dividends are generally distributed every quarter, but some companies also offer monthly or yearly distributions. It depends on the decision-making and policies of the company’s senior management. |
Capital gains are realised when the asset is sold at a higher price than its purchase price. |
Conclusion
To wrap up, dividends serve as a method for companies to distribute their earnings to shareholders, and they occupy a crucial position in the investment approaches of many individuals.
By understanding what is dividend in stock market, how dividends are paid, and the difference between dividend payout ratio and dividend yield, you can make better investment decisions. Whether you are a beginner or someone looking to enhance your portfolio performance, keeping an eye on dividends can help you achieve your investment plans.
What Are Dividends? – FAQs
Q1: How to invest in dividend stocks?
Several investment options are available for dividend stocks; you can choose shares of an individual company, ETFs, or dividend mutual funds. Open a brokerage account to easily buy dividend stocks.
Q2: What is the difference between interest and dividends?
When you lend your money to others, like the government or banks, you earn a small amount called interest. Whereas, when you buy shares from a company, you become a part-owner. A portion of a company’s profits is paid to its shareholders, which is called a dividend.
Q3: Why do some investors prefer the highest dividend paying stocks in India?
Dividends are an additional source of income, so many investors often prefer the highest dividend paying stocks. Investors are attracted to the dual appeal of steady dividends and potential capital appreciation. In India, many investors actively seek high dividend-paying shares as these companies not only ensure a regular income generation but also serve as a sign of a company’s solid financial health.
Q4: Do dividend stocks pay monthly?
Normally, dividends are paid quarterly, but some companies offer annual and monthly dividends too. It depends on a company’s management and board of directors when they want to distribute dividends.
Q5: Do we have to pay tax on dividends?
Yes, in India, income from dividends is taxable in the hands of shareholders.
Q6: Are dividends irrelevant?
Dividends are not irrelevant to several investors who want to generate a regular income stream from dividends, for the image of a company, and financial strategy.
Q7: Who doesn't pay a dividend?
Young startups, fast-growing companies typically do not pay dividends as they are often in the early stages of development, and prefer to reinvest all the earnings and profit for future projects.