What are dividends?
The stock market is a vast space for investors to explore and yield profitable returns. While risks and profits are inevitable in this field, one can ace the game of investing in the stock market with appropriate knowledge and ample practice.
With time, one can not only discover the most high-yielding shares in the market but can also avail of certain benefits. One such perk is a dividend.
By definition, a dividend is a distribution of monetary profits accumulated by a corporation in its journey of growth and success. This dividend (a share of the sum total profit) is given to the shareholders of the corporation.
As a company records surplus profit, it is eligible to offer dividends to its stakeholders. The value of this dividend given to each stakeholder is determined by the institution's board.
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As a reward for the investors who invested their money into the growth of an organization, a dividend is a way to express gratitude and retain their support throughout.
While dividends can be in the form of stock or cash, there are a number of types of dividends that one must know about.
"While the major portion of the profits is kept within the company as retained earnings—which represent the money to be used for the company’s ongoing and future business activities—the remainder can be allocated to the shareholders as a dividend. "
Types of Dividends
In this segment, we will explore the various types of dividends.
Types of Dividends
While rewards can be given in any form to the shareholders, cash dividend accounts for monetary rewards in the form of cash.
Either electronic transfers or physical cheques are provided to all the shareholders based on their equity share in the company's funds. The transfer of economic value generally leads to a dip in the share price of the company.
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While cash seems to be the best possible way of giving dividends, there are other types of dividends prevalent in the market. One of them is the stock dividend.
Stock dividend refers to a share of the company's wealth in the form of shares or stocks. This dividend is provided to the shareholders in proportion to their investment in the company.
What's more, stock dividends are given in the place of cash dividends when the country is running low on liquidity.
Another type of dividend is property dividend. Herein, a company extends its dividends to the shareholders in the form of physical assets or subsidiaries.
Unlike the first two types, property dividend does not provide cash or stocks. Rather, it provides ownership or partial control over some physical assets owned by the company.
Again, this type of dividend is also extended in proportion with the contribution of the shareholders.
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Until now, we have discovered that dividends are extended rewards to shareholders of a company when the company records growth and progress.
However, a dividend, in reality, is an extension of a company's monetary resources to the shareholders who have contributed to the company's growth.
This is particularly well-explained by the 4th type of dividend - liquidating dividend. This dividend is paid out at the time of liquidating/ closing a company or a business.
At the time of closure of a company, dividends are paid out to the eligible shareholders as an indication of clearing out all debts and underlying obligations.
Liquidating dividends are perhaps accounted to be the last payments a company makes before calling it quits on the field. However, this is also done in accordance with the dividend policy that is followed by a particular company.
What is a Dividend Policy?
For any dividend that is to be paid out, a policy is a must. Like any other policy that dictates the terms and conditions of a company's operations, a dividend policy too dictates the terms by which a company has to operate.
In this case, the policy focuses on the payment of dividends. Simply put, a dividend policy reflects on the terms on which dividends of a company are to be paid out and at what frequency (intervals).
There could be a number of factors affecting dividend policy. However, based on the different types, a dividend policy is recognized by a company and exercised throughout.
The dividend policy plays an important role in this respect. When a company makes profits and starts progressing at the commercial end, the board of directors has 2 choices before them.
First, they can retain the monetary profits for the betterment of the company and additional investments.
Second, they can pay a proportion of that profits as dividends to the shareholders. In the case of the latter, a company has to decide what type of dividends are to be paid out and at what time intervals.
"Some researchers suggest the dividend policy is irrelevant, in theory, because investors can sell a portion of their shares or portfolio if they need funds. "
Significance of dividends
However, if a company decides to retain its profits for the company's welfare, then those expenses are to be duly recorded in the company's balance sheet. In such a scenario, the company exercises a no dividend policy.
Yet, that is not our main point of concern in this blog. Dividend policies, in a way, define the way a company plans on organizing its profits and paying out dividends to its shareholders.
In the upcoming segment, we will discover the various types of dividend policies.
Types of Dividend Policy
This blog is all about dividends and dividend policy. While we have already learned about dividends and its various types, we will now understand the dividend policy types that are relevant in the corporate sphere. Let us get started.
Stable Dividend Policy
The first type of all, stable dividend policy is quite understandable by its name. As the name itself suggests, stable dividend policy refers to the payment of stable (fixed) rates of dividend by a company to its shareholders.
Irrespective of the company's profits or losses, the company is liable to pay its shareholders a fixed amount of dividend, as laid down in the stable dividend policy.
For instance, a company determines that its dividends will be paid out at the rate of 4%.
Perhaps the company underlines this value and is responsible for paying out 4% to all its shareholders regardless of the fact that it has recorded a success or a loss in that financial quarter or year.
The importance of stable dividend policy is immense as it ensures a fixed source of income for the shareholders.
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Regular Dividend Policy
In the case of a regular dividend policy, a company does not determine the rate of dividend, but the frequency of the payment. This implies that the dividends received by the shareholders under this policy are 'regular'.
Let us suppose that a company decides to pay out its dividends at the interval of each year. Perhaps the company will be responsible for paying out dividends every year.
In this case, the dividend amounts are generally low as excesses can be retained by the company in the case of losses. However, such a type of dividend policy represents a low-risk company that pays out regularly.
Irregular Dividend Policy
As opposed to the above-mentioned dividend policies, this one is quite different. As Irregular Dividend Policy puts it, any company has the full liberty to manage its profits in any way that it finds fit.
In this case, the company can distribute irregular dividends. For instance, in times of excess profits, a company could wish to distribute dividends that are not stable.
They could increase or decrease in proportion with the net profit recorded by the company. However, in times of losses, a company could wish to hold back its dividends or even choose to pay out very little amounts.
All in all, it is up to the company to manage its commercial profit under this category of dividend policy. Such companies demarcate less liquidity, high risks, and less reliability.
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To sum up, dividends and dividend policy is a concept that must be known to one and all looking to invest in companies. For any shareholder, a dividend is as important as any other source of income.
Defined as a payout in proportion with the commercial support a shareholder has provided to the company, a dividend is distributed to a company's shareholders. It can be of different types - cash, stock, property, or liquid amount at the time of closure.
Yet, this is not it. A dividend policy is what commands a company to distribute its dividends in a given manner. There are 3 types of dividend policies - stable, regular, and irregular.
While no dividend policy is also a type, it is generally referred to as a situation wherein a company does not distribute dividends at all. Thereby, there's more to dividends than just profits.