To achieve good returns in share market, one should choose stocks that pay high dividend. In the recent years, Indian markets have faced huge ups and downs. Though the stock value has not appreciated considerably, many companies have given decent dividends for their investors. On investing in stocks that provide consistent dividends, there are two benefits. First one being the profit from the stock value appreciation. Secondly, there is tax-free dividend. That being said, to get good returns, one should definitely go for stocks with high dividend records. There may be many doubts with respect to dividends for new traders. First let’s get those doubts cleared.
Three types of profit utilization A company can make use of its profit in the following three ways,
- Entire profit can be used for the business expansion, debt reduction or new acquisitions.
- Or, a part of the profit can be given as dividend for the investors.
- Or, the company can choose to carry out both of the above options.
Dividend is nothing but a part of profit gained by company being equally distributed among the shareholders. Sometimes, though the company has recorded loss in a particular period, it can still choose to reward its shareholders through dividend from its excess cash reserve. Also, it is not mandatory for the company to pay dividend every year. Dividends can be paid in the middle of the financial year (known as interim dividend) or at the end of the financial year (known as final dividend).
SEBI’s dividend norms
In general, dividends are announced as certain percentage. Dividend on a stock is given on the basis of face value of the stock. There is so much of uncertainty here as the face value of the companies differs widely. Furthermore, certain companies are involving in practices such as consistently reducing the face value so as to have huge volume on their stocks or splitting of the stocks often.
So, SEBI has insisted that a company should clearly announce how much “Dividend per Share” is awarded to the shareholders.
Book Closure Dates
Each company listed on the index will announce “Book Closure” dates in order to verify investor information, to determine the eligible shareholders who will be benefited from the dividends, bonuses or preference shares and to decide on Annual General Meeting dates. It contains a start date and an end date. For example, if a company announces book closure dates from Feb 4th to Feb 11th, in order to claim our benefits, especially dividends, we should have got the stock delivered to our demat account on or before Feb 3rd.
A company will announce a date to determine the shareholders entitled for the benefits provided, particularly dividend. This date is known as record date. For example, if a company announces Feb 4th as the record date for providing interim dividend to the shareholders, then we should have taken delivery of the stock into the demat account before Feb 4th in order to be eligible for the dividend payout.
This date is determined by the stock exchange. For example, when Cummins India had declared Feb 15th, 2014 as record date for the interim dividend, NSE declared Feb 13th as Ex-dividend date. This means that, those who buy the share on or after Ex-date are not entitled for the dividend. In the same context, those who sell the share before Ex-date are also not eligible for the dividend. Ex-dividend date is usually 2 business dates before the record date. This is because, normal settlement takes T+2 days. When the stock is traded on ex-dividend date, the value usually drops to the extent of dividend paid per share. Reason being that the dividend paid amount is no longer a part of company’s wealth.
Companies should inform about the book closure dates, record date and the applicable benefits to NSE, seven days in advance. But it is enough to intimate two days in advance, about the board meeting date in which the dividend yield percentage will be determined. In the Cummins India example sighted before, board meeting was held on Feb 4th on which dividend yield was announced. Once, when Coal India declared an interim dividend of Rs. 29 per share, it was announced only 2 days before the ex-dividend date. Since there was a huge gap between record date and the declaration date, trading happened on a mere estimation and the stock ended up trading at a high value already when the dividend was declared. Many investors feared a fall on ex-dividend date and didn’t go for the stock. As expected, there was a huge fall on the ex-dividend date.
Basic Reasons for selecting stocks based on dividend
Following are the reasons one should consider for selecting the stocks based on dividend performance.
1. Companies those are widely popular and known by everyone.
2. Companies those have paid dividend continuously for the past 5 years.
3. Fair dividend yield
4. Fair dividend cover
If a stock bought for Rs. 100 pays a dividend of Rs. 5, Percentage of return on the investment made is known as dividend yield.
Dividend Yield = Dividend per share/Current market price X 100
If the stock price falls, dividend yield will increase. If the dividend yield is too high, it indicates a problem with the company. This is because, the share price tend to fall only when the company is dealing with too many issues. In the Bombay stock exchange index – BSE, average dividend yield of the company ranges between 2 to 5 percent.
Dividend cover is a parameter used to figure out whether the company has provided dividend from the current year’s profit or from the sustained profits. It can be calculated easily as follows,
Dividend Cover = Earnings per Share/Dividend per Share
Generally dividend cover value is considered good if it is between 2 and 3. A value below 1 indicates a huge crisis in the company. When investment is made on stocks considering the dividend returns, it is necessary to note the current price of the share. If the value is too high or if it is near 52 weeks high, it is better to wait for a correction in the stock.