Everyone wants to make money in the stock market, hoping their capital multiplies as soon as possible. When we buy some shares at Rs 700 and it becomes Rs 1,500, we jump in delight. We would have found our multi-bagger! But is this the only way to make money in the stock market? No, we’re not talking about trading, 😂! Another way of having a passive income from investing is through dividends.
What are dividends?
Dividends are profit portions that a company pays to its shareholders. The dividend amount is proportional to the number of shares held. In layperson terms in stock market technical analysis course, dividends are rewards to shareholders for investing in the company. Similarly, the company isn’t obliged to pay dividends. Some provide a handsome dividend, some give small ones and some simply don’t – it’s their choice. Many popular companies give good amounts of dividends to their shareholders.
Why does the dividend amount vary?
The reason is pretty simple-company size. It is because bigger companies have a higher probability of having huge surplus profits after expense deduction than small companies. The one with more surplus profits will distribute more dividends. A medium or small-sized company would prefer to reinvest all the surplus profits they make to foster their growth. Thus, small companies rarely give a lot of dividends or don’t give at all. Also, this is the reason behind the variation in the dividends distributed.
How is the dividend amount decided by the company?
Most shareholders remain confused about the dividend amount calculation. We’re sure that you would also find people doing calculations on the current share price. It is wrong! Companies calculate and distribute dividend amounts on a certain percentage of the face value of the shares. It has nothing to do with the share’s current price. Though, the percentage is proportional to the surplus profits.
We understand that you would have trouble absorbing this. So, let’s take an example to understand the calculation, as you would in a stock market training institute:
Suppose the face value of ABC Ltd. shares is Rs 10. The number of shares in circulation on all exchanges is 10Cr. The results of the P&L of Quarter 4 are out and they are exemplary. The company has generated a surplus profit of 160Cr. The company reinvests 50% of the surplus shares and distributes the rest as dividends. Hence, the company will give a dividend of Rs 8 per held share to its investors, which is 80% of its face value (80Cr divided by 10Cr shares). So, if someone has 100 shares of ABC Ltd., then they get Rs 800 as an additional reward. Voila! 80% has no relation to the current share price at all, unlike most retail investors think.
What is the purpose of giving dividends to the shareholders?
If you think logically, dividends consume the company’s share of profits. As a long-term investor, you would want the company to grow exponentially. Thinking as an amateur, you might perceive dividend distribution as robbery of growth potential. But when you think like a business owner, dividend distribution is a pretty solid scheme.
1. They distribute it amongst the shareholders, so shareholders’ trust remains in the company.
2. With lucrative dividends in an exceptional quarter, they can find many new investors.
3. Companies distribute dividends to send a global message that the company is doing well financially.
4. It enables investors to see the positive finances and profitability of the company, fostering faith.
Coca-Cola is well-known for being a good dividend-paying company. They have consistently increased their dividend since its inception.
The dividend amount is not much. Is it overrated?
Mr Buffett is one of the biggest shareholders in Coca-Cola. Because of his humongous holding, he has earned approximately $592 million only from Coca-Cola dividends in 2017. To put this in perspective, this is ten times more than the compensation of the Coca-Cola CEO. From this case, you would have known the power of dividends taught in share market courses online. Thus, becoming a big investor with the stock accumulation will open doors to a new income source- Dividend Income.
Dividend Investment and Reinvestment strategy:
The dividend investing strategy is an underrated strategy in the investing world. The primary aim is to earn passive income through investing and holding quality companies. Good dividend yield and payout ratio are the other two required filters for stock selection in this strategy. Mr Kevin O Leary is one of the most popular dividend investors in the world. As per him, a company has to prove itself over years by consistently generating cash flows. Only then it is wise to invest in it.
One might think it’s a very easy strategy and we’re just probably overemphasizing. But it is certainly not, and thus uncommon in Stock market courses for beginners! Simply picking the highest dividend yield companies might land you up with eroded capital. The best example of this is Coal India. In the past 5 years, the amount you would have invested would have eroded roughly by 50%. In the reinvestment strategy, people who have a small portfolio should simply reinvest the dividends back into their portfolio. They should buy some more shares to build their portfolio.
Relevant terms in Dividends:
Ex-Dividend Date- The expiry date for being eligible for a dividend is called the ex-dividend date or ex-date. Suppose the Ex-Dividend Date of ABC Ltd. is 21st September, then those who wish to get the dividend will have to buy the shares before 21st September.
Record Date- The day on which the shareholders should have the shares present as delivered in their portfolio. If the shares are not present in delivery mode, then the shareholder is not eligible for any dividend payment. It is two to three days after the Ex-Dividend Date.
Payment Date- The date when the company provides dividends to eligible shareholders is the Payment Date.
Types of Dividend- Interim and Final Dividend
Interim dividend: Company pays it before the AGM and release of final financial statements. They pay it out from profits kept by a company. It is a small amount.
Final Dividend: The company pays it at the end of the FY after calculating the earnings. Unlike interim dividends, they are bigger.
Is a high dividend-paying company always a healthy company?
Hell, no! A company might shell huge dividends but still be suffering in various sections. They can even give dividends for the simplest of reasons-They don’t know what to do with the money. Coal India is such an example. Are they a very efficient company? Being a PSU, probably not! Why? It’s because we are not going towards a coal-dependent economy. Other notable examples are BP, IOC, etc.
TCS is another very high dividend-paying company but well managed with good fundamentals. It also has a wonderful future ahead, being the segment leader. Hence, investing in TCS for dividends is a better decision than in BPCL or IOC despite a higher dividend payout than TCS. Thus, the role of fundamental analysis of Indian stocks becomes important in dividend investing.
Dividends are a great tool to make consistent money from the stock markets. However, it takes time to do it if someone starts with small capital. It is a snowball strategy of Stock market courses for beginners where dividends need to be reinvested and holding quantity increases slowly, resulting in more dividends. Remember, to ensure a healthy passive income and a comfortable future, investment needs to be done wisely.
Credits: Arsh Ahluwalia (Ex-Team Member)