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What are Dividend Stocks? Definition & Types of Dividend Stocks

Updated on :  

08 min read.

What are Dividend Stocks?

Stocks that pay regular dividends are called dividend stocks. These well-established companies have a track record of distributing profits to their shareholders. Dividends are cash rewards that a company gives to its shareholders. 

Companies may offer dividends through interim dividends and final dividends. Interim dividends are dividend payments made before a firm’s annual general meeting (AGM). However, final dividends are declared by the Board of Directors after a firm issues its financial statements.

How to calculate dividend yield?

You could check the dividend yield of stocks to pick the right dividend stocks. It is determined by dividing the dividends announced by its share price and then multiplied by 100. Suppose Company X, with a share price of Rs 50, offers a dividend of Re 1 per share. The dividend yield is 2%. 

You may consider investing in shares of high dividend-yield firms for regular income. For instance, if a company has a dividend yield of 3% to 4% per year, you may get capital appreciation and dividend income. 

Dividend stocks are suitable for investors who seek regular income. Many companies that offer dividends have solid financials; you enjoy capital appreciation and dividend income over the long term. 

How to pick the right dividend-paying stocks?

Pick the right sectors:

You must pick stocks of the right sectors if you seek regular dividends. For instance, you could start by looking at the best-performing sectors such as IT and pharmaceuticals and pick top-performing companies which pay consistent dividends. 

You could also look at the sectors which could grow rapidly and stay profitable over the coming years. After sorting out the relevant sectors, you go to the next step, looking for shares of companies that offer high dividend yields. 

Check the dividend payout ratio of the company:

Look at companies with a minimum dividend payout ratio of around 40%-50%. It is the ratio of the total dividends paid out to shareholders to the company’s net income. 

For instance, the higher the dividend payout ratio greater the risks the company must take to avoid dividend cuts even if things go wrong. Companies in the high growth phase look to expand and grow rapidly by investing heavily in their business. 

Moreover, these firms have a lower dividend payout ratio as they prefer reinvesting their earnings in the company rather than paying out dividends to shareholders. You could consider looking at stocks of well-established companies with a higher dividend payout ratio. 

Look at the dividend policy of the company

A company’s dividend policy shows how the firm structures dividend payouts to shareholders. Moreover, the company’s dividend policy also dictates the frequency of dividend payouts to shareholders.

The company’s dividend policy divides its earnings into two parts:

  • Retained Earnings
  • Dividends 

Retained earnings offer funds to finance a company’s long-term growth. However, the firm’s dividend policy impacts wealth creation and long-term financing. You must look at companies which follow a stable dividend policy which means regular dividends to shareholders. 

Consistent increase in the dividend yield 

It would help to focus on stocks of companies that consistently increase dividend yield over time. Suppose a company’s net profits go up; it pays higher dividends to shareholders. 

Another reason a company should increase its dividend yield is the shifts in its growth strategy. For example, suppose a company decides to shift its focus from growth and expansion; it will have a larger share of profits to distribute as dividends to shareholders.

What are the types of dividend stocks?

Cash Dividends:

Cash dividends are a common form of dividend payouts. The company will issue dividends to its shareholders, and the money will be distributed directly into their bank accounts as per their shareholdings. 

Stock Dividends:

If a firm issues additional shares to its shareholders, this is a stock dividend. Here dividends are paid out to shareholders through shares rather than cash. 

Moreover, stock dividends can reward the firm’s shareholders without reducing the cash balance though it dilutes EPS. (Earnings Per Share).

Property Dividends:

Companies may issue non-monetary dividends to shareholders called property dividends. The property dividend will be recorded against the current market price of the asset which is being distributed. 

Property dividends serve as alternatives to cash and stock dividends. However, property dividends are not as common. 

Scrip Dividends:

Under scrip dividends, the dividend payments take place under scrips or promissory notes. Suppose a company needs cash generated through its business operations to meet the firm’s business requirements. It will withhold cash dividend payments as it faces a temporary cash shortage. 

In such situations, the firm will issue scrips or promissory notes promising to pay dividends in the future. However, the scrips will have a definite maturity date. There are cases where the company does not stipulate a maturity date, and payments are left at the discretion of the Board of Directors. Moreover, the scrips may be interest or non-interest bearing. 

Liquidating Dividends:

It is a type of dividend that a company pays its shareholders during a full or partial liquidation. Companies distribute such dividends only once during their lifetime. However, it does vary in the case of partial liquidation of firms, and such dividends are not liable to tax. 

Special Dividends:

Companies distribute special dividends when they have excess cash profits. Moreover, special dividends are often higher than regular dividends. Special dividends result from extraordinary events or firms distribute them when they achieve phenomenal success. 

Conclusion:

  • Companies pay dividends in cash or shares based on a schedule.
  • There are several dividend stocks, and you must pick the right ones based on your needs.

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