Imagine you are going trekking in mountains or doing scuba diving and enjoying all the days of a year without worrying about your work or day-to-day expenses because all your living expenses are being taken care of by the dividends income that you get from the company. This scenario is a dream for millions of people and one happy thing is that this lifestyle is achievable. But to achieve that, you must first completely understand dividend investing. This beginner’s guide will help you to get started in the world of dividend investing.
Companies that earn a profit can either pay that profit out to shareholders; reinvest it in the business through expansion, debt reduction, or do share repurchases or both. When part of the profit is paid out to shareholders, the payment is known as a “dividend”
Dividends must be approved by a company’s board of directors each time they are paid. There are four important dates to remember regarding dividends:
1. Declaration date: The declaration date is the day the board of directors announces its intention to pay a dividend.
2. Ex-dividend date: This is the day,on which any new purchases of the stock are not entitled to the approved dividends
3. Date of record: This date always follows the ex-dividend date. It is the day upon which the stockholders must be on the company’s record books in order to be eligible to receive that period’s dividend. It’s basically the ex-dividend date on the company’s side, whereas the previous date concerns the exchange itself.
4. Payment date: This is the date the dividend will actually be given to the shareholders of the company.
Different Types of Dividends
Regular cash dividends are those paid out of a company’s profits to the owners of the business. Investors receive the dividend amount credited directly into their bank accounts.
Interim or Special Dividends
In addition to regular payouts, there are times when a company may pay a special one-time dividend. These are rare and can occur for a variety of reasons, such as a major litigation win, the sale of a business, or the liquidation of an investment. For example: In April 2021, Britannia Industries paid a special dividend of Rs 62 to its shareholders.
Stock Dividends or Split
A dividend is paid in stock shares rather than cash. A company may opt for stock dividends for a number of reasons, including inadequate cash on hand or a desire to lower the price of the stock on a per-share basis in order to prompt more trading and increase liquidity (i.e., how quickly an investor can turn their holdings into cash).
Is paying high dividends good for the company
A company should only pay dividends if it is unable to reinvest its cash at a higher rate than the shareholders are able to if they receive a dividend.
So, if company ABC is earning 30% on equity with no debt, the board should elect to retain all of the earnings, because the average investor probably won’t find another company or investment that is yielding that kind of return.
At the same time, an investor may require cash income for living expenses. So company management should take a balanced approach in such a way that, they retain some portion of the profit for future expansion at the same time they also give adequate dividends for the investor.
Additional ways that companies and stockholders can evaluate dividends involve the payout ratio and dividend yield.
Dividend Payout Ratio
The percentage of net income that is paid out in the form of a dividend is known as the “dividend payout ratio.
For example: if the company earns a profit of Rs 100 and pays Rs 50 as a dividend. Then the dividend payout ratio is 50%. This indicates that the company has paid 50% of its profit as dividends to its shareholders.
The dividend yield tells the investor how much they are earning on common stock from the dividend alone, based on the current market price. It is calculated by dividing the actual or indicated annual dividend by the current price per share.
For example: if the CMP of the company is Rs 100 and the dividend per share is Rs 5. Then the dividend yield is 5%. This indicates that the investor will get 5% of his capital as dividends every year from the company.
Selecting High-Dividend Stocks
An investor who desires to put together a portfolio that generates high dividend income should place great scrutiny on a company’s dividend payment history. Only those corporations with a continuous record of steadily increasing dividends over the past 10 years or longer should be considered for inclusion. The investor should be convinced that the company can continue to generate the cash flow necessary to make the dividend payments.
Dividends Depend on Cash Flow
Dividends are dependent upon cash flow, not reported earnings. Almost any board of directors would still declare and pay a dividend if cash flow were strong. The reason is simple: investors who prefer high-dividend stocks look for stability in cash flow
A company that lowers its dividend will probably experience a decline in the stock price as investors sell and take their money elsewhere. Accordingly, companies will not raise the dividend rate just because of one successful year. Instead, they will wait until the business is capable of generating cash to maintain the higher dividend payments. Likewise, they will not lower the dividend simply because they think the company is facing temporary problems.
Criteria for selecting dividend stocks
1. Cash flow from operations growing at greater than 10% in last 10 years.
2. Dividend payout ratio greater than 30% consistently for last 10 years.
3. Low CAPEX requirement and low/nil debt.
4. No Equity Dilution in the last 10 years.
Power Of Dividend Growth
In the last 10-15 years, you will find that not only stock prices of the company grew more than 25% CAGR for last 10 years. The dividend also has grown at 25% CAGR for the last 10 years. For example, Pidilite Industries dividends per share in FY12 was Rs 1.9, and in FY21 it is Rs Rs 8.5. Dividends per share have grown at a CAGR of Rs 17.5%.