Why do people invest in stocks or equities? Any guesses? Investors invest in stocks to be awarded either in the form of dividend distribution or in the form of dividend distribution. Stock investors need to be well-versed in fundamental and technical analysis to earn a decent income from the stock market, which is highly volatile in nature. They are more exposed to market risk. Before investors start investing in stocks, they should understand how stock investments affect them economically.
What is a dividend? A dividend is a part of the earnings of a company and is allotted to stakeholders as per the norms set by board of directors. The sole purpose of the distribution of dividend is to return wealth back to equity shareholders. Dividends are of several types. Stock dividends and cash dividends are the main categories of dividends.
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Stock dividends, also referred to as scrip dividends, are common nowadays. They are the dividend payment done in the form of extra shares. Companies may go for stock dividends if their liquid cash availability has been in short supply. They have a tax benefit. It means that stockholders are not taxed until they sell the shares. XYZ Company Limited has 1 lakh shares and has decided to declare a stock dividend of 5%. In this case, the number of the company’s share will increase to 1,05,000 shares from 1 lakh shares. If you owned 100 shares of this company, after declaring a 5% stock dividend, you will now get five extra shares (5% of 100). It means you have 105 shares in total.
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Cash dividends are the cash payments made by a company to its shareholders. Most companies prefer this option to share their profits. They declare cash dividends periodically. Cash dividends are remitted on a per-share basis. It is worth mentioning that each business enterprise formulates and follows its own dividend policy and regularly evaluates whether or not a dividend cut or a rise in dividend is required.
The board of directors of an enterprise will announce cash dividends on a stipulated date, which is called a dividend declaration date. The dividend declaration date includes remitting a definite amount of money per share. The record date is generated once the notification is sent. The record date is the date on which a company decides who are qualified to receive the dividend.
Joseph owns 1,000 shares of a technology company. The company has consistently delivered dividend payments over the last few years. The board of directors of the company has decided to declare a cash dividend of Rs.5 per share this year also in order to maintain its financial ratios and entice more investors. In this case, Joseph gets Rs.5,000 (1,000X5) as cash dividends.
Companies share their part of profits via announcing stock dividends or cash dividends. If a company decides to allot additional shares, it shall declare stock dividends. On the other hand, if it decides to pay cash as a return to its shareholders, cash dividends are declared.
Put simply, cash dividends are the dividends paid in the form of cash and stock dividends are the dividends paid in the form of additional shares. The question now is which is the best option? From the stance of shareholders, stock dividends are the best choice as they receive extra shares. When stockholders receive cash as a dividend, they spend money. It means they are left with nothing. Companies will decide whether to declare a cash dividend or a stock dividend based on business requirements.
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There is always a confusion amid stock investors that who are eligible to receive stock dividends. The simple answer to this question is that the stock investors whose names are present on the record book of the company are eligible to get stock dividends. Similarly, companies will list the people who are eligible to receive cash dividends.
The biggest advantage of paying cash dividends is that business entities may help provide shareholder loyalty. The companies with a good history of cash dividend payments are anticipated to maintain the same. The major disadvantage of cash dividend payouts is that the money remitted to shareholders cannot be utilized to grow or expand their business. When stock investors receive dividends (stock or cash), they become more confident about their companies. Stock dividends are helpful to create value in the long-run.
Do I need to pay taxes on dividends? Dividends received from Indian companies are exempted from tax since the companies declaring such dividends deduct dividend distribution taxes prior to making the payment. The dividends collected are chargeable to tax at 10% in case of residential individuals, Hindu Undivided Families (HUFs) and firms as introduced by the Finance Act 2016. On the other hand, the dividends received from overseas companies are taxable and in this case, the income tax is levied under the head of income from other sources.
Stock and cash dividends are the two common forms of dividends. They are declared to prove profitability and build brand reputation. Both options have certain merits and demerit, but stock dividends are more beneficial to shareholders.
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