This is the fourth part of the Making Sense of Stocks series In case you missed the previous part go check it out and then come back for a better understanding.
This blog will talk about one of the most common ways of generating income from the stock market i.e. Dividends.
What is a Dividend?
A dividend refers to the distribution of a firm's earnings among its shareholders. Dividends are distributed based on shares owned by an individual, and they are announced on a per-share basis. For example, If Company A declares a dividend of Rs.10/Share.
The decision regarding the payment of dividends is taken by the management of a firm, they may or may not decide to pay dividends. Equity shareholders do not have a fixed rate of dividend which means the rate at which equity shareholders are paid dividends depends on the decision of the management. On the other hand, the rate at which preference shareholders are given dividends remains fixed.
Preference Shareholders are entitled to receive dividends before equity shareholders. This holds even at the time of liquidation (closing) of the company, where the obligations to preference shareholders are settled before those to equity shareholders. This practice ensures that external liabilities are settled first, beginning with bond/debentures and banks, followed by preference shareholders, and finally, equity shareholders.
Equity shareholders enjoy a notable advantage over preference shareholders i.e. the rate of dividend is not fixed for equity shareholders. So in case of higher profits equity shareholders may receive a higher rate of return as compared to preference shareholders. This is because when a company experiences significant profits it is obligated to pay dividends to preference shareholders at a fixed rate. However, the company's management may decide to distribute dividends to equity shareholders at a higher rate.
Taxation on Dividend
NOTE- For a better understanding of Taxation kindly visit the income tax website.
Investors are required to pay tax on dividends in accordance with their income slab rates. This is due to the fact that dividend income is classified as income from other sources and is added to the total taxable income. To illustrate this point, consider the following example:
If person A has an income of Rs. 10 lakhs receives a dividend of Rs.1 lakh in the financial year. So the total taxable income becomes Rs.11 lakhs, in such a case person A would fall in the 30% tax slab and would have to pay dividends accordingly.
Payment of Dividend
Interim Dividend
Interim Dividend refers to the dividend paid by the firm before publishing the final results by a company. This type of dividend is declared before the end of the financial year* i.e. before 31st March. The rate of the interim dividend is generally lower than the rate of the Final Dividend.
Final Dividend
The final dividend refers to the dividend declared by the firm at its Annual General Meeting (AGM) for a given financial year. The rate of the final dividend is higher than the rate of the interim dividend.
In a scenario where both interim and final dividends are paid in the same financial year, the rate of final dividends is higher than the rate of the interim dividend.
Special Dividend
Special dividend refers to dividends that are not a part of a company's regular dividend policy, instead, they are paid on an irregular or infrequent basis. Such dividends are paid when a company has excess cash which does not need to be used for momentum or future projects.
Important Dates to Look Out For
An investor must keep in mind the following dates related to dividends.
Announcement Date- The board of directors announces the payment of the dividend on this date.
Record Date- It refers to the date on which a shareholder must be on the company's record of shareholders to receive the dividend.
Ex-Dividend Date (Ex-Date) - It refers to the date on which stocks begin trading without a dividend attached to it. This means shareholders who have bought the shares on or after the ex-dividend date would not be eligible to receive dividends from the company. Ex-date is usually one day before the record date, however, it is not necessary for it to be that way.
NOTE (IMP) - In India stocks are now settled on a T+1 basis this means it takes one business day from the day of purchase for the owner to change in the records. For example, If A buys a stock from B today, then the record books would show A as the new owner after one business. Thus, investors who buy stocks on or after ex-date don't receive dividends as their name is not shown in the records of the company.
Payment Date - It refers to the date on which the dividend amount is credited to the bank account of the shareholders.
*Financial Year- Financial Year refers to the time period from 1st April of the current year to 31st March of the successive year. For e.g. Financial Year 2023 refers to the time period from 1st April 2023 to 31st March 2024.