What is a dividend in the share market?

Companies that earn a profit may (after paying their creditors) choose to reinvest that profit into business, pay it to shareholders, repurchase shares or pay off their debts. When the payment is made to shareholders, it is known as a dividend. These payments are usually made in cash which is known as a cash dividend, but in some cases, they may choose to make these payouts in the form of stocks too which is known as a stock dividend.

The dividend yield is often an essential factor for investors when choosing which stocks to invest in. The dividend yield is calculated on the current share price.

Example: If ABC Ltd declares a dividend of Rs.5/share and the market value of the share is Rs.250 then:
Dividend Yield = Full-year Dividend/Current Share Price
In this case it is: 5/250 = 0.02 or 2%

Paying dividends does not impact the fundamental value of a company’s share price. Companies that are at an early stage of their life cycle and have a high growth choose to usually reinvest most of their profits in the company to facilitate growth. Well established companies pay regular dividends to reward loyal shareholders.

What is a Stock Dividend?

A stock dividend can be described as an increase in the number of shares of a company; the new shares are given to existing shareholders. These shares are paid on a pro-rata basis to the existing shareholders. These payments are generally made in fractions and are paid per share.

How do Stock Dividends work?

A company may choose to pay stock dividends for multiple reasons; the first being they do not want to reduce the company’s cash balance or wish to reward the shareholders despite having insufficient cash reserves. Stock dividend payout may reduce the share price, which may prompt increased trading and improve liquidity. Lower share prices increase liquidity as there is a more significant likelihood of someone selling a share that is priced at Rs. 100 rather than selling one that may be priced at Rs 5000.

For investors who are looking at getting immediate cash flows, cash dividends may seem like a better option. On the other hand, stock dividends offer a choice to the investor. They may choose to remain invested in the company with larger shares in the hope that the company will perform better with the reinvested funds or they may decide to sell some new shares and generate cash flows for themselves.

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DISCLAIMER

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.



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