Why dividends are important in stock market investing. Let’s understand everything about dividends in simple language.
As India's economy grows, investors hope for good returns in the medium to long term. While stock market growth is important for wealth creation, many overlook dividends. However, dividends play an important role in increasing investors' returns. They can increase the total return from investments and help build wealth over time.
For example, the Nifty 500 index grew at a compounded rate of 12.5% from January 2000 to July 2024. But if we include dividends through the Nifty 500 Total Return Index (TRI), the growth rate rises to 14.2% during the same period. This shows that dividends contributed an additional 1.7% to the overall returns.
This 1.7% increase may seem small, but over 24 years, it can make a huge difference. If an investor had invested ₹1 lakh in the Nifty 500 TRI in January 2000, it would have grown to ₹26 lakh by now. Without dividends, the investment in the Nifty 500 index would have reached only ₹18 lakh. So, over 30% of the returns in the last 24 years came from dividends alone.
That’s why dividends are important in stock market investing. Now, let’s understand everything about dividends in simple language.
In the stock market, dividends are payments made by a company to its shareholders. The company's board of directors decides the amount. Dividends are usually paid quarterly, either in cash or as additional shares.
Dividends provide returns at regular intervals for investors, helping them assess a company’s performance and growth potential. It is easy to track dividend returns from top dividend-paying companies in India, allowing investors to see how well their investments are performing. Shareholders who own stocks before the ex-dividend date are eligible to receive these dividends.
Also, it’s important to note that dividends are not paid in derivative trading because it doesn’t involve ownership of shares. Derivatives, such as options and futures, derive their value from underlying assets like stocks, commodities, or indices, but they don’t include direct ownership of these assets.
The company's board of directors will declare the dividend on this day. The amount and timing of the dividend payment will be specified. This date is significant because it provides investors with income projections for the future.
For investors, the ex-dividend date is quite important. It’s the cut-off date for getting the dividend. You will not be eligible for the upcoming dividend if you purchase the stock on or after this date. You must own the shares before the ex-dividend date to be eligible for the dividend.
The record date is when the company checks its records to see who the shareholders are. As a shareholder, you will get the dividend if your name appears on the list by this date. The ex-dividend date is typically one business day later.
On this date, the dividend is actually distributed to stockholders. The company either issues checks to shareholders or transfers the dividend amount to their accounts, which can be accessed through a demat account mobile app.
Companies can distribute dividends to shareholders in various ways. Understanding these types helps investors know what to expect:
Cash Distributions: This is the most common form, where companies transfer cash directly into shareholders’ accounts.
Stock Payouts: Instead of cash, companies might offer extra shares to shareholders.
Dividend Reinvestment Programs (DRIPs): These allow investors to reinvest their dividends into the company’s stock, often at a lower price. It’s optional—investors can choose to take cash dividends instead.
Special Payouts: These are one-time payments distributed to all common shareholders, often using profits accumulated over several years.
Preferred Stock Dividends: These are paid to preferred shareholders. Usually fixed, they are similar to bond interest payments and are distributed quarterly.
To assess a company's dividend strength and compare it with others, investors can use a few essential methods:
This shows how much dividend a company pays out for each share over a certain period. A company with a history of increasing its DPS year after year is usually more attractive to investors. It helps determine whether the company can keep growing its dividend payouts over time.
This ratio can be found on financial websites or through online brokers. It is calculated by dividing the annual dividend by the stock’s current price. Using this metric, investors may more precisely compare stocks that pay dividends.
This ratio shows the percentage of a company's profit that goes towards paying dividends. A payout ratio of 100% or over indicates that the business is giving away all or most of its profits as dividends, which might be risky if the business experiences financial difficulties. Investors usually seek payout rates of 80% or lower for dividend stability.
Paying dividends doesn’t necessarily change a company's overall value. But, it does reduce the company’s equity by the dividend amount. After the dividend payment, this amount is permanently removed from the company’s books.
When a company declares a dividend, its stock price usually rises as investors anticipate the payout. However, after the ex-dividend date, when new buyers are no longer eligible for the dividend, the share price often falls.
If market sentiment stays positive until the ex-dividend date, the stock price might increase more than the dividend amount. Despite price swings, these movements can contribute to a company’s overall stock value in the long run.
Dividends provide a reliable source of income for investors, especially during market downturns. This regular payout can help balance out stock price fluctuations and offer a more consistent return even when the market is volatile.
Investors can use dividends to purchase more shares of the same stock through Dividend Reinvestment Plans (DRIPs). This can help grow their investment over time, as reinvesting dividends can lead to compound growth and increase long-term returns. Many SIP apps offer Dividend Reinvestment Plans (DRIPs) as an option, allowing investors to automatically use the dividends they receive to purchase additional shares of the same stock.
Companies that consistently pay or even increase dividends show strong financial health and profitability. A steady dividend payout can indicate that a company is well-managed and confident in its future earnings.
Dividends increase an investment's overall return. In addition to price appreciation, dividend payouts help in the total growth of a portfolio. This can make a big difference, especially when dividends are reinvested.
In general, dividend-paying shares are seen as less risky than non-dividend-paying stocks. These shares typically come from more financially secure, established companies. They may not always see rapid price increases, but long-term investors may find them a safer option due to their consistent payouts.
Note: When looking at different investment options, derivative trading can help diversify your portfolio. To begin, you need to open a demat account to hold your securities electronically. Many investors use a SIP app or a demat account mobile app for easy management of their investments, making it simple to track and invest in stocks, including those that pay dividends.
Also read about Mahurat Trading 2024
In conclusion, dividends are an important part of overall returns, especially when you hold investments for a long time. They show how well a company can generate cash and are usually associated with steady growth. Therefore, when creating your investment strategy, it's really important to pay attention to dividends and growth.
Dividend stocks are shares of companies that regularly share a portion of their profits with shareholders through dividends.
It depends on your investment goals. Dividend stocks can be a great choice if you seek regular income. On the other hand, growth stocks might appeal more to those aiming for higher capital gains.
To receive dividends, you must own shares of the dividend-paying company before the ex-dividend date. Dividends are distributed to shareholders based on their shareholdings.
Companies pay dividends to share profits with shareholders and to attract investors. Increasing dividends over time signals stability, making these companies attractive for dividend investment.