What do dividends do

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The benefits to investors include steady flows of income. However, an important part missing in many of these discussions is the purpose of dividends and why they are used by some companies and not by others. Before we begin describing the various policies that companies use to determine how much to pay their investors, let's look at different arguments for and against dividend policies. Some financial analysts believe that the consideration of a dividend policy is irrelevant because investors have the ability to create "homemade" dividends.

These analysts claim that income is achieved by investors adjusting their asset allocation in their portfolios.

For example, investors looking for a steady income stream are more likely to invest in bonds where the interest payments don't fluctuate, rather than a dividend-paying stock, where the underlying price of the stock can fluctuate. As a result, bond investors don't care about a particular company's dividend policy because their interest payments from their bond investments are fixed.

Another argument against dividends claims that little to no dividend payout is more favorable for investors. Supporters of this policy point out that taxation on a dividend is higher than on a capital gain. According to proponents of this policy, a company's alternatives to paying out excess cash as dividends are the following: undertaking more projects, repurchasing the company's own shares, acquiring new companies and profitable assets, and reinvesting in financial assets.

Proponents of dividends point out that a high dividend payout is important for investors because dividends provide certainty about the company's financial well-being. Typically, companies that have consistently paid dividends are some of the most stable companies over the past several decades. As a result, a company that pays out a dividend attracts investors and creates demand for their stock. Dividends are also attractive for investors looking to generate income. However, a decrease or increase in dividend distributions can affect the price of a security.

The stock prices of companies that have a long-standing history of dividend payouts would be negatively affected if they reduced their dividend distributions. Conversely, companies that increased their dividend payouts or companies that instituted a new dividend policy would likely see appreciation in their stocks. Investors also see a dividend payment as a sign of a company's strength and a sign that management has positive expectations for future earnings, which again makes the stock more attractive.

A greater demand for a company's stock will increase its price. Common shareholders of dividend-paying companies are typically eligible as long as they own the stock before the ex-dividend date. Dividends may be paid out as cash or in the form of additional stock. Dividends must be approved by the shareholders through their voting rights. Although cash dividends are the most common, dividends can also be issued as shares of stock or other property.

Along with companies, various mutual funds and exchange-traded funds ETFs also pay dividends. They may do so to maintain their established track record of making regular dividend payments. The board of directors can choose to issue dividends over various time frames and with different payout rates. Dividends can be paid at a scheduled frequency, such as monthly, quarterly, or annually. For example, Walmart Inc. Companies can also issue non-recurring special dividends , either individually or in addition to a scheduled dividend.

Backed by strong business performance and an improved financial outlook, Microsoft Corp. Larger, more established companies with more predictable profits are often the best dividend payers.

These companies tend to issue regular dividends because they seek to maximize shareholder wealth in ways aside from normal growth.

Companies in the following industry sectors are observed to be maintaining a regular record of dividend payments:. Companies structured as master limited partnerships MLPs and real estate investment trusts REITs are also top dividend payers since their designations require specified distributions to shareholders.

Funds may also issue regular dividend payments as stated in their investment objectives. Startups and other high-growth companies, such as those in the technology or biotech sectors, may not offer regular dividends. Because these companies may be in the early stages of development and may incur high costs as well as losses attributed to research and development, business expansion, and operational activities, they may not have sufficient funds to issue dividends.

Even profit-making early- to mid-stage companies avoid making dividend payments if they are aiming for higher-than-average growth and expansion, and want to invest their profits back into their business rather than paying dividends.

Dividend payments follow a chronological order of events and the associated dates are important to determine the shareholders who qualify for receiving the dividend payment. Therefore, dividend payments impact share price, which may rise on the announcement approximately by the amount of the dividend declared and then decline by a similar amount at the opening session of the ex-dividend date.

Keep in mind that this may or may not happen, but the price should adjust, lowering the share price by the dividend on the ex-dividend date. Companies pay dividends for a variety of reasons. These reasons can have different implications and interpretations for investors. Dividends can be expected by the shareholders as a reward for their trust in a company.

The company management may aim to honor this sentiment by delivering a robust track record of dividend payments. Dividends are also preferred by shareholders because they are treated as tax-free income for shareholders in many countries. Conversely, capital gains realized through the sale of a share whose price has increased are considered taxable income. Traders who look for short-term gains may also prefer getting dividend payments that offer instant tax-free gains.

A high-value dividend declaration can indicate that the company is doing well and has generated good profits. But it can also indicate that the company does not have suitable projects to generate better returns in the future.

Therefore, it is utilizing its cash to pay shareholders instead of reinvesting it into growth. If a company has a long history of dividend payments, a reduction of the dividend amount, or its elimination, may signal to investors that the company is in trouble.

A reduction in dividend amount or a decision against making any dividend payment may not necessarily translate into bad news about a company. It may be possible that the company's management has better plans for investing the money, given its financials and operations. For example, a company's management may choose to invest in a high-return project that has the potential to magnify returns for shareholders in the long run, as compared to the petty gains they will realize through dividend payments.

Dividends paid by funds are different from dividends paid by companies. Company dividends are usually paid from profits that are generated from the company's business operations. Funds work on the principle of net asset value NAV , which reflects the valuation of their holdings or the price of the asset s that a fund may be tracking.

Due to the NAV-based working of funds, regular and high-frequency dividend payments should not be misunderstood as a stellar performance by the fund. For example, a bond-investing fund may pay monthly dividends as it receives money in the form of monthly interest on its interest-bearing holdings. The fund is merely transferring the income from the interest fully or partially to the fund investors.

A stock-investing fund may also pay dividends. Its dividends may come from the dividend s it receives from the stocks held in its portfolio, or by selling a certain quantity of stocks. It's likely the investors receiving the dividend from the fund are reducing their holding value, which gets reflected in the reduced NAV on the ex-dividend date.

Economists Merton Miller and Franco Modigliani argued that a company's dividend policy is irrelevant and it has no effect on the price of a firm's stock or its cost of capital. In the case of high dividend payments, they can use the cash received to buy more shares. Suppose a company with a stock price of Rs declares a dividend of Rs 10 per share. High dividend yield stocks are good investment options during volatile times, as these companies offer good payoff options.

They are suitable for risk-averse investors. The caveat is, investors need to check the valuation as well as the dividend-paying track record of the company. Companies with high dividend yield normally do not keep a substantial portion of profits as retained earnings.

Their stocks are called income stocks. This is in contrast to growth stocks, where the companies retain a major portion of the profit in the form of retained earnings and invest that to grow the business. Dividends in the hands of investors are tax-free and, hence, investing in high dividend yield stocks creates an efficient tax-saving asset. Investors also take recourse to dividend stripping for tax saving. In this process, investors buy stocks just before dividend is declared and sell them after the payout.

By doing so, they earn tax-free dividends. Normally, the share price gets reduced after the dividend is paid out. By selling the share after the dividend payout, investors incur capital loss and then set off that against capital gains. Definition: Dividend refers to a reward, cash or otherwise, that a company gives to its shareholders. Dividends can be issued in various forms, such as cash payment, stocks or any other form.

However, it is not obligatory for a company to pay dividend. Dividend is usually a part of the profit that the company shares with its shareholders. Description: After paying its creditors, a company can use part or whole of the residual profits to reward its shareholders as dividends. However, when firms face cash shortage or when it needs cash for reinvestments, it can also skip paying dividends. When a company announces dividend, it also fixes a record date and all shareholders who are registered as of that date become eligible to get dividend payout in proportion to their shareholding.

The company usually mails the cheques to shareholders within in a week or so. Stocks are normally bought or sold with dividend until two business days ahead of the record date and then they turn ex-dividend. A recent study found that dividend-paying firms in India fell from 24 per cent in to almost 16 per cent in before rising to 19 per cent in In the US, some of the companies like Sun Microsystems, Cisco and Oracle do not pay dividends and reinvest their total profit in the business itself.

Companies with high growth rate and at an early stage of their ventures rarely pay dividends as they prefer to reinvest most of their profit to help sustain the higher growth and expansion. On the other hand, established companies try to offer regular dividends to reward loyal investors.

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