An investor invests in a stock with the expectation that the stock prices would rise and he/she can capitalize on the increase in the value of the share. Shareholders also expect the company to share its profit. The amount each shareholder receives out of the company profits is known as dividend. Dividend is distributed on a pro-rata basis or in the proportion of holding by each shareholder. Dividend is a corporate action and is at the discretion of the company’s board of directors. It is distributed to shareholders, usually twice in a year in the form of a final dividend and an interim dividend. Dividend is a source of income for the shareholder and is expressed on a ‘per share’ basis.

Dividend reduces the company’s assets (cash) and the retained earnings thereby reducing the net worth. If a company’s earnings per share in the year is INR 6 and pays out INR 3 per share as a dividend, it is passing half of its profits on to shareholders and retaining the other half. Dividends are treated differently in different countries from tax perspective. For example, in India dividend received by any Indian company is tax free under section 10(34) of the Income Tax Act.

Important terms related to dividends

Declaration date: The date on which the directors announce the dividend known as Declaration date.

Ex-date: The date of which the seller of the security is entitled to receive the dividend declared. The ex-date is usually two business days before the record date.

Record date: The date decided by the issuers of the securities to determine the holders who are entitled to receive dividends. This is to ensure that the dividends are paid to the right person.

Payment date: The date on which the dividend is paid to those shareholders whose name appears in the company records on the record date. People who bought the share before ex-date receive the dividend on the payment date.

Types of dividends

Dividends may be in the form of cash, stock or property. Dividend paid in cash is known as Cash Dividend and dividend paid in stock is known as Stock Dividend. Most of the secure and stable companies offer dividends to their stockholders. Their share prices might not move much, but the dividend attempts to make up for this. A High-growth company would distribute part of its profit as dividend and invest the rest in expansion or growth projects.

Effect of dividends on share prices

Effect of cash dividends on share price: Cash dividend reduces the total assets and the net worth of the company. The market price of the share drops in most cases by the amount of cash dividend distributed.

Effect of stock dividends on share price: The stock dividends do not increase the net worth of the company or the shareholder as the market value of the share drops in most cases. Market price of the stock changes depending on the investor’s expectation.