When listed companies earn profits, some of them decide to retain the profits and reinvest in the business, while others decide to distribute them to their shareholders. The profits are distributed by the companies to the shareholders in the form of dividends. In simple words, dividends are the profits distributed to the shareholders of the company. Let’s understand them in detail and what happens to the unclaimed dividends of the shareholders.
How Do Dividends Work?
In India, the company's distribution of dividends is regulated by the Companies Act, 2013. Once the company earns profits, it may decide to distribute dividends to the shareholders.
The dividends are usually denoted as a percentage of the face value of shares. For instance, if a company decides to distribute a 10% dividend and the face value of its shares is Rs. 100, then it will pay Rs. 10 per share as a dividend to the shareholders.
However, in certain situations, the company pays the dividend, but the shareholders do not claim it. The dividend is to be paid by the company on demand and therefore is its liability.
If the shareholder does not claim dividends within seven years, then such unclaimed dividends shall be transferred to the Investor Education and Protection Fund (IEPF) account. However, the shareholder has the right to claim the unclaimed dividend at any point in time.
Types of Dividend
The following are the different types of dividends that a company may pay to its shareholders:
The final dividend is paid to the shareholders after the end of every financial year. It is proposed by the board of directors and approved by the shareholders in the general meeting. Final dividends are paid after the finalisation of the annual accounts of the company.
The dividend paid between two general meetings of the company is called the interim dividend. It can be paid at any time between the two general meetings. However, companies usually prefer to pay interim dividends after declaring their quarterly results.
The two types of dividends paid by the companies are described above. However, it is not necessary that the dividends always be paid in cash. The following are the ways in which the dividend is paid to the shareholders of the company:
- Cash dividend: Cash dividends are one of the most common types of dividends, and most companies prefer to pay their dividends by directly crediting the amount in the shareholder’s bank accounts. However, for large companies with numerous shareholders, it is important to have the required liquidity to pay dividends in cash.
- Stock dividends: These are usually given in the form of the issue of shares to the shareholders. Also known as the issue of bonus shares, here, the companies usually allot more shares to the shareholders at a predetermined ratio based on the existing shares. For instance, a bonus issue in the ratio of 1:2 implies that the company will issue 1 share for every 2 shares held by the shareholders.
- Property dividend: Companies can issue non-monetary dividends to the shareholders by distributing their assets. A property dividend or asset dividend is usually distributed when the company no longer requires an asset and wants to distribute it to the shareholders.
In India, usually, dividends are distributed in cash or through the issue of bonus shares.
Advantages and Disadvantages of Dividend
There are advantages as well as disadvantages to dividend payments, both to the company and shareholders.
If the company decides to retain the profits instead of distributing them as dividends, it can compound those profits. However, if the company decides to pay dividends to the shareholders, there will be an outflow of resources from its books.
Dividends are paid from the company's reserves, which form part of equity. Distributing dividends leads to a reduction in the company's equity value as it directly reduces the reserves that the company is holding.
For shareholders, dividend payments are a source of passive income. However, if the company retains the profits, it can lead to compounding and exponential growth in its share value.
Impact of Dividends on Share Prices
Once the company declares the dividend, it also declares a record date. All the shareholders holding shares on the record date are eligible to receive the dividend. Therefore, investors, in order to book extra income in the form of a dividend, start buying shares of such a company.
The price of such shares starts to increase, and investors are even ready to pay a premium to buy them. However, once the record date expires, further investors won’t be eligible to receive the dividend. As a result, there is a fall in the share price because investors are no longer willing to pay a premium price for the shares.
Dividend Payout Ratio vs. Dividend Yield Ratio
Most often, people confuse the dividend payout ratio with the dividend yield ratio. However, there is a clear difference between the two.
The dividend payout ratio indicates the portion of the company’s earnings being paid to the shareholders as dividends. The dividend yield ratio indicates the rate of return that shareholders earn on their investments. The following are the formulae for these terms:
Dividend Payout Ratio = Annual Dividends Per Share / Earnings Per Share
Dividend Yield Ratio = Annual Dividends Per Share / Price Per Share
Let’s understand this with a practical example:
If the earnings per share are Rs. 1000 and the annual dividend of the company is Rs. 100, then the dividend payout ratio is 10%.
Further, suppose you have invested Rs. 2000 in a company’s shares, and you receive a dividend of Rs. 100 per share. Then the dividend yield ratio for you shall be 5%.
Dividend vs. Buyback
In both dividend and buyback, the shareholders receive the payment from the company. However, there is a difference between both.
A dividend is when a company shares profits with its shareholders, while a buyback is when the company buys back its shares from the shareholders. Both these steps are taken by the company when it has excess liquidity and has earned good profits.
Chronology of Dividend Issue
From declaration to payment, issuing dividends is a four-step process. The following dates are prominent when it comes to the declaration and payment of dividends:
- Dividend declaration date: This is the date when companies declare their dividends.
- Dividend record date: Dividends are paid to the shareholders whose names appear in the list of shareholders on the record date.
- Ex-dividend date: Ex-divided date is when all the newly purchased and sold shares are not entitled to the dividend declared.
- Dividend payment date: This is the date when the dividend is paid to the shareholders.
Best Dividend-Paying Stocks of 2023
As discussed earlier, not all companies pay dividends to shareholders. You can invest in dividend-paying stocks if you want to earn a good passive income. The following are some of the best dividend-paying stocks of 2022:
- Britannia Industries
- Punjab National Bank
- Balkrishna Industries
- Dr. Lal PathLabs
- Dalmia Bharat
- Polycab India
- Indian Hotels Company
- Happiest Minds Technologies
In a Nutshell
Dividend-paying stocks are a preferred investment avenue among investors. They provide a passive income, and their capital appreciation contributes to wealth creation. Further, investors can also go with dividend-paying mutual funds if they are new to investing or cannot put in adequate time in researching stocks. Dividend-paying mutual funds invest in high dividend-paying companies. If you are keen on investing in stocks, understand the category under which the stock falls and the implications of dividends beforehand.
Note: this article is not a piece of investment advice. Professional consultation prior to making any significant investment decisions is highly advised.
Frequently asked questions
Do dividends attract income tax?
Yes. Earlier, the dividend income was exempt in the hands of the shareholders because the companies used to pay the dividend distribution tax (DDT). However, in February 2020, DDT was abolished, and now investors are liable to pay tax on their dividend income.
Within how many days shall the company pay dividend after its declaration?
The company shall pay dividends within 30 days of the company's declaration.
What is the tax rate applicable to dividend income?
The dividends shall be taxed at the rate applicable to the taxpayers. Therefore, if you fall into the 20% tax bracket, you will pay tax at the same rate on your dividend income.
What is the difference between unclaimed and unpaid dividends?
The unclaimed dividend is the dividend paid by the company but not claimed by the shareholders. However, if the company does not pay a dividend after announcing it, then it is known as an unpaid dividend.
Is unclaimed dividend an asset or a liability?
Unclaimed dividend is a liability because companies are required to pay the dividend amount to shareholders whenever demanded.
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