Introduction
Dividends are payments made by companies to shareholders as a reward for investing in the company. They are usually paid out quarterly or annually, and businesses can offer various types of dividend. In this article we will look at and discuss the different types of dividends and how they work. We will also look at some of the advantages and disadvantages of each type. Knowing the types of dividends available can help you make a well informed decision about investing in stocks. So let's dive in and look at the different various forms of dividend.
What are Dividends?
Companies reward their shareholders by paying out dividends. These payments can be made in the form of cash, stocks, other assets, and more; they are also typically based on the company's profits but could come from debt instruments. Depending upon a given firm's dividend policy, these payouts may happen quarterly or annually - all while being subject to taxes. Investing in stock with the potential for dividend returns is an attractive way to build wealth over time!
The types of dividends a company pays out depending on the types of securities they offer. Common types include ordinary (cash) dividends, stock/share, property, and liquidating/special dividends.
What are the Different Types of Dividends?
If you want to know what are the types of dividend that businesses pay out, each with its advantages and disadvantages, keep reading.
1. Cash dividends
These are the most common type of dividends, paid out in cash. A company pays out a certain portion of its profits as dividends to shareholders. For example, An IT firm, XYZ, has made Rs 500 crores in profit for the year 2020. They decided to pay their shareholders 20% of that amount as a dividend, which would be Rs 100 Crore INR (500 Cr x 0.20).
This would mean each shareholder would receive a certain dividend amount, depending on how much stock they own.
The advantages and disadvantages of cash dividends depend on the company's financial situation. On the one hand, shareholders can benefit from receiving a dividend payment in the form of cash; on the other hand, companies have less money to reinvest in their businesses, which can limit growth potential.
Cash dividends provide an immediate return but also mean less money for companies to reinvest and grow.
2. Stock dividends
As the name suggests, stock dividends are paid out as additional shares instead of cash. For example, XYZ IT firm decided to pay its shareholders 20% of its profits as a stock dividend. This would mean each shareholder will receive an additional share for every five shares they own.
The advantage of stock dividends is that they can increase a shareholder's potential returns without them having to invest more money. Additionally, companies won't have to part with their profits as they do with cash dividends.
On the downside, they also don't provide immediate benefits and tend to carry more risk than cash dividends. The market value of the new shares could be lower or higher than when the original investment was made.
3. Property dividends
These various forms of dividend are paid out as assets instead of cash or shares. This could be anything from real estate to antiques and can even include intangible assets such as patents or copyrights.
The advantage of property dividends is that they can diversify an investment portfolio and may provide more tax benefits than other types of dividends. On the downside, there is always a risk that the value of these types of assets may decline over time, limiting potential returns.
For example, XYZ IT firm pays its shareholders 10% of its profits as property dividends. This would mean each shareholder will receive an additional asset worth Rs 50 Lakhs INR (500 Cr x 0.10).
4. Scrip dividends
Scrip dividends are similar to stock dividends, but instead of receiving additional shares directly from the company, shareholders receive a scrip or voucher that can be exchanged for shares on the market.
The advantage of scrip dividends is that they can provide more flexibility to investors as it allows them to decide when and how much of their dividend money should be used for reinvestment. On the downside, there is always a risk that the value of these types of assets may decline over time, limiting potential returns.
For example, XYZ IT firm decides to pay its shareholders 10% of its profits as a scrip dividend. This would mean each shareholder will receive a scrip worth Rs 50 Lakhs INR (500 Cr x 0.10) that can be exchanged for market shares later.
5. Liquidating dividends
Liquidating dividends are paid out to shareholders when a company is winding down its operations, and there isn't enough money left to pay out other different types of dividends.
The advantage of liquidating dividends is that they can provide a return for shareholders even if the business has failed. On the downside, it typically means that all remaining assets will be sold off to pay the dividend, and the company will cease to exist.
For example, XYZ IT firm decides to pay its shareholders 50% of its remaining assets as a liquidating dividend. This would mean each shareholder will receive an amount equivalent to Rs 250 Lakhs INR (500 Cr x 0.50) from the sale of the company's assets.
Impact of Dividend on Share Prices
The impact of dividends on share prices depends on the types of dividends being paid out. Cash dividends tend to have a positive effect on share prices as investors are immediately rewarded for their investment. Stock dividends can also increase the value of shares, but it depends on how well the company performs in the future and whether or not the new shares will be worth more than originally purchased. Property and scrip dividends may also have an impact depending on their market value at the time of payout. Liquidating dividends usually lead to a decline in share prices as all remaining assets are sold off, leaving shareholders with no prospect of further returns.
As a shareholder, knowing about different types of dividends payouts before investing in any portfolio is recommended to know what to expect from your investments.
Calculation of Dividends
Dividends are calculated based on the company's profits, and the board of directors determines the amount paid. The most common way to calculate dividend payment is through a "dividend per share," which represents how much each shareholder will receive for every share they own. This number is usually derived from the total earnings available for distribution divided by the total shares outstanding in that particular period.
For example, XYZ IT firm earned Rs 500 Cr in net profits this quarter, and there are 10 Lakhs shares outstanding. So, each shareholder will receive Rs 50 (500 Cr / 10 Lakhs) as their dividend per share.
Depending on the different types of dividends being issued, additional calculations may be required to determine the exact amount of money each shareholder will receive.
Functioning of Dividends
● Firstly, with tremendous income and a substantial accumulation of retained earnings, publicly-listed companies are incredibly successful.
● Secondly, it is not uncommon for companies to reward their shareholders by distributing part of those profits as dividends.
● Thirdly, there are different types of dividend, such as cash dividends, stock dividends, and property or scrip dividends.
● Fourthly, liquidating dividends are paid out when a company is winding down its operations, and there isn't enough money left to pay other types of dividend.
● Fifthly, the impact of dividends on share prices depends on the types of dividend being paid out and can fluctuate upon receiving payments.
● Sixthly, dividends are calculated based on the company's profits and usually distributed in a "dividend per share," which represents how much each shareholder will receive for every share they own.
● Finally, shareholders need to understand the types of dividend being paid out and any additional calculations that come with them before investing in a portfolio.
● Additionally, it's important to understand the important dates related to dividend payments, such as when the ex-dividend date is and how it impacts share prices.
Dividend and Financial Modelling
Dividend and financial modelling is the process of predicting how a company's dividend payments will affect its stock price. It involves taking into account different types of dividends, including cash, stock, property, or scrip dividends, as well as the impact of taxes on dividend income and any additional calculations required for each type of payment. In addition to predicting share prices, this modelling can also be used to identify potential opportunities for investors in terms of when it may be beneficial to purchase more shares or sell their existing holdings.
This is how dividends affect a company's financial statements:
Financial Statement | Impact from Dividend Payment |
Income Statement | Decrease in profit after taxes as a result of dividend payment |
Balance Sheet | Increase in liabilities due to the dividend payable amount. Decrease in retained earnings and cash for payment of dividends. |
Cash Flow Statement | Dividend payments show up as an outflow under the "financing activities" section |
Statement of retained earnings also shows the impact of dividend payments.Comprehending the impact of dividends on a company's finances is essential for investors when assessing potential investments.
Meaning of Dividend Stocks
Dividend stocks allow investors to own shares of a publicly-listed company and earn dividends from their investment. When the company's profits reach a certain level, it can choose to distribute some or all of it as dividends to shareholders. The types of dividend paid out can vary depending on the company but typically include cash, stock, or property dividends.
The impact on share prices will be determined by the types of dividend given out and any additional calculations related to them. Additionally, it is important to understand the associated dates of dividend payments to make informed decisions and maximize returns. Dividend stocks can be a great way of earning passive income while growing one's portfolio over time.
Dividend Payout Ratio vs. Dividend Yields
The dividend payout ratio refers to the portion of a company's earnings that are distributed as dividends. In contrast, dividend yields refer to the annual return rate on investment based on the current market price of shares. Dividend payout ratios can be calculated by dividing total dividends paid for a given period by net income earned during the same period. On the other hand, the dividend yield is calculated by dividing total dividends per share (DPS) by the market price per share.
Conclusion
Dividends can be a great source of passive income for investors. Understanding types of dividend, their impact on financial statements, and associated dates of payments are essential when assessing investments. Dividend payout ratios and dividend yields provide insight into how much an investor will receive in the form of dividends per share they own. With this knowledge, investors can make informed decisions when choosing stocks and maximizing investment returns.
