In general, a company’s dividend policy encompasses the amount of dividend to be paid to the eligible shareholders and the frequency with which dividend is to be distributed. After reporting profit, the companies must decide on what needs to be done with the surplus; they could either retain it for financing their future growth or they can distribute it among their respective shareholders in the form of dividends. Dividends, usually the small portion of the companys’ profit or in other words the usage expenditure incurred by the corporations for utilising shareholder's money are distributed among the various stakeholders, with highest risktakers, equity shareholders getting the preference over the other stakeholders.
Dividend shared by the corporation could be in the form of cash dividend and bonus shares. When the dividend is paid out in cash from the company’s cash reserves, it is called cash dividend; it reduces the cash resources of the corporations. On the other hand, bonus shares as dividend, which is also known as capitalisation issue, refers to the shares the company offers to the existing shareholders at no additional cost. It increases the company's share capital at the expense of the reserves. In the case of bonus dividend, there is a reclassification of the liabilities’ side of the balance sheet with reserves declining along with a corresponding surge in the share capital.
Few dates synced with the payment of dividend needs to be elaborated:
Dividend Announcement date: Let’s take an example of a company XYZ, which announced a dividend of 100 pence per share as on July 15. The date on which dividend was announced by the board of the company is called announcement date or declaration date. Both non-executive directors and executive directors of the board together decide and approve the amount of dividend to be paid to the shareholders. Then starts the process of dividend distribution.
Record date: The record date for the dividend is mutually decided by both executive and non-executive directors of the corporation, and it is the date on which shareholders must be on the books of the company in order to receive the dividend. The dividend is paid to all shareholders whose names are recorded in the list of shareholders of the company at the end of business hours on the record date. Generally, the record of shareholders of a company to decide the entitlement of dividend is maintained by the registrar and transfer agents. So, let's say, the XYZ company's board decided on the record date of August 10, then all shareholders whose names appear in the company’s records at the end of August 10 will be entitled to receive the dividend. But there is a technical issue here; when one buys shares of a company, he gets delivery of the shares only after T+2 days that is on the second trading day after the transaction date. That is where the concept of ex-dividend date comes into play.
Ex-Dividend date: The ex-dividend day actually addresses the issue of T+2 delivery system. The ex-dividend is fixed as the day preceding the record date. Generally, the ex-dividend date is one business day before the record date and, in case there is a holiday on the scheduled day, then the ex-dividend date is adjusted back accordingly. In the above case, the record date is August 10, and hence the ex-dividend date will typically be August 09.
So, what does this ex-dividend date indicate?
One needs to buy shares before the ex-dividend date so that he could get the delivery of the shares by the end of the record date and will become entitled to receive dividends. Stocks traded in the UK market generally take two business days to settle. Therefore, if you initiate a trade today, it will take two business days after the trading day before your depository participant have actually received the shares from the seller. The crucial point here is, if you buy shares on August 09, which is ex-dividend date in our case, you will not qualify to receive dividends, but if you buy shares on August 08, even if you had hit the last trade on that day, you might be entitled to get dividend on the dividend payment date.
Book Closure date: Generally, during the book closure period, any transfer of share requests is not entertained by the registrar. For instance, if you buy shares during the book closure or if you buy shares just prior to the book closure, then you will get the actual delivery of shares only after completion of the book closure period.
Actual dividend payment date: The final step is the actual payment of the dividends; on the payment date, your dividend will get credited automatically to your registered bank account.
Taxes associated with dividend
In the UK, generally, dividends are exempted from any tax unless received by a bank or a financial institution or an insurance company.
Should new buyers consider buying stocks before the ex-dividend date?
A lot of noise is there in the market that one can just buy shares before it goes ex-dividend and sell it just on the ex-dividend date. Well, there is no free lunch and dividends are not provided as a freebie. The dividend itself gets neutralised in the short-term because there is an automatic adjustment in the stock price. The price of the stock usually drops by the amount of the dividend on the ex-dividend date.
So, if you buy a share just before the ex-dividend date, on the trading session of the ex-dividend date, the dividend will get adjusted in the stock price, and then the stock could continue to move downward or upward based on the market forces like demand and supply and sentiments; so the dividend is not essentially a freebie.
Dividends are really a long-term play. The way we look at it is this; in order to get benefited from the dividends, one should have held the scrips at least as long as it took the company to earn enough money to pay the dividends. So, even though there are strategies out there, sometimes people talk about "dividend capture", like there is some sort of magic formula here to just make money by buying stocks in order to get dividends and then selling them right away. It generally doesn't work, and there's really no reason to try it.
What about dividend reinvestment?
One of the best ways to grow your investment is by the continuous deployment of the dividends received, further into the stocks. Online stock trading platforms have different alternatives to exercise this, which vary according to the commission and minimum charges involved. But in case you hold physical share certificates, the majority of FTSE 100 companies would allow you to participate in a scheme known as the Dividend Reinvestment Plan (DRIP).
Are stocks with high dividend yields always a good bet?
A stock could be having abnormally high dividend yield because of the company's sliding share prices, perhaps due to performance risk. As a company's share price drops, the yield shoots up. If there has been a dramatic slump in share price leading to an eye-catching yield, it typically reflects poor scenario on the prospects of a company and would cast doubt on its ability to maintain pay-out in future as well.
However, time and often, it has been proved that equity as an asset class is a more valuable investment vehicle against the other assets like gold and bonds (this although depends on an investor’s requirement as well). As in the present economic scenario with multiple macro-economic challenges, bond yields are plummeting as demand for the bond has shot up amid jolted investor sentiments. Likewise, gold too, does not provide any kind of regular income and is utilised by investors for the purposes of hedging. Therefore, at present equity can be called one of the best available asset class for investors in the UK financial market, subject to the need of the investors.
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