Dividend is the share of the profit that a company decides to distribute to its shareholders. While the company pays tax on the distributed dividends, the shareholders can enjoy their dividends tax-free. Dividends are paid out of the standalone profits of the company. Thus, if a company has made loss on standalone basis and its subsidiaries are profitable, the company would not be able to pay out dividends.
Typically, profitmaking public sector undertakings and multi-national companies pay dividends consistently to reward their parent owners. Older, well-established companies tend to payout a higher percentage of their profits as dividend than their younger, growth-oriented peers. Moreover, larger players have a more consistent dividend history.
Pay or Plough back?
When a company earns profits, it has to decide how much share of profit it wants to fork out to its shareholders. The rest can then be either retained or re-invested in the company’s operations. Ploughing back doesn’t necessarily imply that the company is not in favour of distributing dividends. If the company is just retaining its earned profits, it could mean that it is building reserves either for expansion or for any acquisition. Reserves are also used up when the company intends to issue bonus shares to its shareholders.
What is dividend payout ratio?
Dividend payout ratio is the percentage of earnings a company pays out to its shareholders as dividends. Sifting through the history of a company’s dividend payout ratio, an investor would get a trend of how much of the company’s profits distribute as dividends. If an investor sees a decreasing trend, he needs to check whether the company is conserving cash for expansion or reinvestment. It is observed that companies that have matured and attained big size have higher dividend payout ratio.
What does it mean?
Dividend yield of a stock signifies how much a company pays dividend in relation to its stock price. It is calculated as a fraction of annual dividends paid by the company upon its stock price. It implies how much return in dividend in a year an investor would get for every `100 invested in the stock price. Thus, higher yield means more returns for the shareholder.
High dividend yield is not always good…
Since dividend yield involves the company’s stock price, it could become exceptionally higher due to a sharp fall in the stock price. Investors have to then be cautious while selecting companies based on high dividend yields. In such cases, it is advisable to look at the company’s financial performance to gauge the likelihood of the company maintaining its past performance on dividend-payments.