Types of Dividends

Companies may pay dividends in several forms, categorized by their nature and frequency. Here are the primary types:

1. Special Dividend

A special dividend is issued when a company has accumulated substantial profits over time. This type of dividend is often seen as a way to distribute excess cash to shareholders.

2. Preferred Dividend

Preferred dividends are paid to holders of preferred stock and usually accrue a fixed amount, typically on a quarterly basis. This type of dividend operates similarly to interest payments on bonds.

3. Interim Dividend

An interim dividend is declared before the preparation of the company’s final accounts for the year. In India, the financial year runs from April to March.

4. Final Dividend

A final dividend is declared after the company's annual accounts have been prepared and approved.

Additional Forms of Dividends:

• Cash Dividends: The most common form, paid directly to shareholders via cheque or electronic transfer.
• Stock Dividends: Issuing new shares to shareholders, distributed on a pro-rata basis.
• Asset Dividends: Rarely, companies may offer physical assets or real estate as dividends.
• Warrants and Financial Assets: Some companies may offer other financial instruments as dividends.

Impact of Dividends on Share Prices

The declaration of dividends can significantly affect a company's stock price. When a dividend is announced, share prices typically rise as investors anticipate receiving dividend income. However, after the ex-dividend date, share prices often fall by the dividend amount, as new investors will not receive the upcoming dividend.

Important Dividend Dates:

• Announcement Date: The date when the company declares the dividend.
• Ex-Dividend Date: The date after which new buyers of the stock will not receive the dividend.
• Record Date: The cut-off date to determine shareholder eligibility for dividends.
• Payment Date: The date on which the dividend is credited to eligible shareholders' accounts.

Calculating Dividends

Dividend Payout Ratio

The dividend payout ratio indicates the portion of earnings distributed as dividends. It is calculated as follows:

Dividend Payout Ratio=Dividends PaidReported Net Income\text{Dividend Payout Ratio} = \frac{\text{Dividends Paid}}{\text{Reported Net Income}}Dividend Payout Ratio=Reported Net IncomeDividends Paid

A ratio of 0% indicates no dividends are paid, while a ratio exceeding 100% may signal unsustainable practices.

Retention Ratio

The retention ratio shows the proportion of earnings retained for reinvestment:

Retention Ratio=Earnings per Share - Dividends per ShareEarnings per Share\text{Retention Ratio} = \frac{\text{Earnings per Share - Dividends per Share}}{\text{Earnings per Share}}Retention Ratio=Earnings per ShareEarnings per Share - Dividends per Share

This ratio helps assess how much profit is reinvested into the business versus paid out as dividends.

Functioning of Dividends

Steps in Dividend Distribution:

1. Income Generation: Companies accumulate retained earnings from profits.
2. Management Decision: Management decides whether to reinvest or distribute retained earnings.
3. Board Declaration: The board announces the dividend rate after obtaining shareholder approval.
4. Announcement of Key Dates: Important dividend dates are communicated.
5. Eligibility Scrutiny: Shareholders’ eligibility for dividends is confirmed.
6. Payment: Dividends are distributed to shareholders.

Dividend and Financial Modelling

Dividends are treated as allocations of retained earnings rather than expenses. Their distribution impacts financial statements as follows:

Understanding Dividend Stocks

Dividend stocks are shares in companies that regularly distribute dividends to shareholders. These companies are usually well-established with a solid track record of profitability.

Considerations for Choosing Dividend Stocks:

• Payout Ratio: Look for companies with a payout ratio of at least 50%.
• Dividend Yield: Aim for a yield between 3% and 6%.
• Financial Health: Companies should have a history of timely dividend payments and manageable debt levels.

Dividend Payout Ratio vs. Dividend Yield

• Dividend Payout Ratio: Reflects the portion of earnings distributed as dividends.
• Dividend Yield: Indicates the return on investment from dividends relative to the stock price.

Calculating Dividend Yield:

• Dividend Yield = Annual dividends per share / Dividends per share