The dividend is normally declared on each share. Even if a company has made a profit it is not obliged to pay any dividend. The board of directors decides whether or not to pay a dividend.

Let us say that a company whose share price is Rs.300 with a face value of Rs.10 declares a dividend of 50%, then the dividend paid will be Rs.5/- per share. (Rs.10 x 50%) and it is not Rs.150 (300 x 50%). The dividend yield, in this case, would be 5/300 = 1.66%

Dividends are seen by the market as an important signal that determines the health of the company. As it is paid out of the reserves, the company is distributing a part of it to the shareholders.

Some consider that paying dividends is a waste. Fast-growing companies are considered to be in a better position to invest the profits back into the business. In India dividends received by the shareholder from equity, is tax-free.

WHAT ARE DIVIDEND PAYING STOCKS?

A stock that pays dividend are shares of a company that pays dividend regularly to their shareholders. These companies are good for investing because, even if the price of shares were to go down, one would still get a fairly good return on their investment by way of dividends. Those investors following an ‘income investing strategy’ usually have a part of their investments in companies paying regular dividends.

Some shareholders reinvest their dividends, thus allowing them to increase the stock. This long-term strategy of dividends helping you to own more stock leads to better returns over some time. Holding stocks paying good dividends for a very long period, and reinvesting the yearly dividend every year, will result in the accumulation of wealth beyond imagination.

UNDERSTANDING DIVIDENDS.

Dividends are declared as a percentage of the face value of the shares, which could range between Rs.1/- to Rs.10/-. A 100% dividend on a share of Rs.1/- share means that the dividend is Rs.1/- a share.

Not every company distribute a major part of their profits to their investors. Some companies invest the money back into the business to generate higher returns in the future. Some companies even after reaching saturation of their capabilities, do not reward their shareholders. Bharti Airtel, although they have been in business for several years, is an example. This company declared its first dividend only during 2009.

Face value of a share

The capital of a company is divided into shares. A company whose capital is Rs.10 crores can be divided into 1 crore shares of Rs.10 each. This is called the face value of the share. When these shares having Rs.10/- face value is traded in the market, the value will go up or down depending on the supply and demand of the stock. The value of the share at any time is the share price or the market value. A share having a face value of Rs.10/- may be sold at a higher market value of Rs.100/- or lower market value of Rs.8/- One has to remember that dividends are declared only on its face value.

WHEN DO THEY PAY DIVIDEND?

Dividends are paid after the recommendations of the board are accepted by the shareholders. The pay-outs of dividends have a direct impact on the company’s cash balance. Although there is no law as such to make regular dividend payments compulsory, several companies make it a regular practice to keep up their reputation among the investors. Dividends are viewed as a sign of prosperity, as this is also the most popular way to reward investors. One must note that it does not mean companies declaring dividends are doing well. It would be wise to make a few tests to assess whether the dividends are an indication of good stocks that one can add to their portfolio.

Dividend Yield.

Dividend Yield is the ratio of the annual dividend amount and the prevailing market price of the share of the company. The ratio of dividend yield ratio will tell what investors would earn on their shares.

Let us say that two information technology companies Wipro and Infosys (the face value of their share is Rs.2/- and Rs.5/- respectively) declare annual dividends of 200% and 270% percent respectively. At the first glance, one might get the impression that Infosys has done better. As dividends are paid on the face value of a stock, one must go by the percentage. In the case of Infosys where the face value is Rs.5/-, the per-share dividend is Rs.13.50, whereas, in the case of Wipro where the face value is Rs.2/-, the dividend is Rs.4/-. But the dividend yield is higher for Wipro (1.2 percent) as the current market price is whereas for Infosys it is lower (0.8 percent).

One can also notice that the companies where promoter holding is high, periodically declare dividends. Companies where the promoter holdings are 45-75 percent, for example, TCS, RIL, HCL, Wipro, and Sterlite Industries, regularly declare dividends.

Coverage of Dividend

The dividend coverage ratio measures the extent a company’s earnings can support its dividend payments. The dividend cover ratio indicates how easy it is for a business to pay a dividend from its profits. A High cover shows that the company is capable to pay the dividend easily while a low value shows that the business may have difficulty in paying a dividend. The formula for dividend cover is:-

Dividend cover

Net profit available to equity shareholders / Dividends paid to equity shareholders

BONUS SHARES

Bonus shares are issued by capitalizing on a portion of the company’s reserves. After a bonus issue, although the total number of shares will increase, the shareholder’s proportional ownership will not change. As the price of share fall in proportion to the bonus issue size, it does not change the shareholder’s personal wealth. A bonus is seen as a strong signal from the company which could result in an increase in demand for the shares thereby making the price move up. As no money was paid to acquire the bonus shares, they have to be valued at zero cost while calculating capital gains.

WHY COMPANIES MAKE A BONUS ISSUE OF SHARES?

· Bonus issue of shares allows a company to declare a dividend without outflow of cash. This could be used for financing investment opportunities in the company, thereby maintaining liquidity.

When the company is not in a position to pay a dividend by way of cash due to liquidity issues, or where there are restrictions for paying a dividend in cash under a loan agreement, bonus issue is the way to satisfy the shareholders or maintain their confidence.

With the issue of bonus shares, the rate of dividend is brought down which results in the price of share also coming down to a range that results in an increase in the trading activity of the stock. The low price of share helps small investors to invest in stocks where the price was high earlier.

As there is no underwriting commission or brokerage, the cost of the bonus issue of shares is very low. Bonus shares are allotted to existing shareholders in proportion to their holdings.