One important thing we hadn’t yet addressed till now, was the question of dividends. So here we go.
To know what are dividends, firstly let’s take a look at what a company can do with the profits it has made. It can either reinvest the money in the business itself. Or it can use the same to pay some debts that it might be having on its balance sheet. And lastly, it can distribute this profit money to its shareholders in the form of dividends. You might have seen in the news companies like ITC, GAIL announcing dividends for their shareholders.
While there are different types of dividend like property dividend, stock dividend, etc., we are only taking a look at the most common and probable dividend you will receive which are cash dividends. As the name suggests, you receive your payment in cash or rather in your bank account to put it clearly.
The Dividend Process
Now lets get on to how is the process of distribution carried out.
First is the declaration date of the dividends, when the board of directors of the company sit down in a meeting and announce their intention to pay a dividend to its shareholders. They will announce a Date of Record, this is the date that decides whether one is eligible for the dividend or not. To be eligible, one has to be a shareholder of the company on the Date of record. And since we know that settlement of stocks is a T+2 process (explained here), this means that even if you buy the stock atleast two business days before the date of record you will be eligible for the dividend. Finally, there is the payment date and yup, you guessed it, this is the day when you will receive your payment or when the dividend is finally paid out.
Look Past the Hullabuloo
Seeing as how one can get some regular income from dividends, one might be tempted at the thought of receiving dividends left, right and center. But hold on to your horses and look a little deeper. First of all you got to figure out your taxes. You might look forward to reinvesting all those dividend gains. But the taxes applicable on your gains might end up reducing them to a proportionally less value.
Secondly, and more importantly rather, the kind of dividend policy a management follows reflects quite strongly on their abilities. A quality management wouldn’t just dole out dividends all the time out of the earnings of the company. They will look for opportunities to invest themselves or look to make the company more efficient (by investing the earnings in the firm itself). This way the shareholder can be benefitted to a much further extent. Another thing you should look out for is that companies shouldn’t have a dividend policy that is always all over the place. They should have a stable dividend policy that is vigorously followed.
Still there are always times when a company should distribute its earnings as dividends and not keep capital lying frozen on its balance sheet. When they feel that the shareholder can make better use of the money and they have exhausted all their opportunities themselves, they are probably better off distributing the earnings as dividends.
As a young investor we would say never forget the reason why you entered into an investment and then dividends and all will serve as additional bonuses only. Whereas if you are looking to retire, you could go for some stocks which offer regular healthy dividends to keep your money flowing in at periodic intervals.