Dividends vs Bonus


WHAT ARE DIVIDENDS ON STOCKS?

When you buy a company’s shares you expect that company to make a profit. The profit that company makes is then divided among the shareholders on a ratio proportional to the number of stocks one has. Dividend on stocks is therefore the proportion of a company’s profit that it pays to its shareholders. This is usually declared as a dividend per share. Although a company makes profit, they are in no way obligated to pay dividends. It’s the managing board’s decision whether to pay or not.

For example - If a company whose share price is Rs. 400, declares a healthy dividend of 60% (face value Rs. 10), the dividend paid would be Rs. 6 per share.( Rs 10 * 60%) and not Rs 240 (400 * 60%). The dividend yield in this case would be 6/400 = 1.5%

Dividends are looked upon by the market at large as an important signaling mechanism determining the health of the corporate. Dividends are paid out of reserves and by paying dividend the company is distributing a part of its reserves amongst shareholders.

  • However, there is a school of thought that considers dividend payouts as a waste of money. Fast growing companies are perceived to be much better off ploughing their profits back.. Equity dividends in India are tax-free in the hands of shareholders.

WHAT ARE DIVIDEND PAYING STOCKS?

Dividend paying stocks are shares of a company that pays regular dividend payments to its shareholders. These are good companies to invest in because even if the stock price was to go down, you still get a worthwhile return in your investment from dividends. Investors who follow the ‘income investing strategy’ may have a portion of their investments in regular dividend paying companies.

  • Some stock owners reinvest dividends, which allow them to buy more stock. That can lead to a great long-term strategy of dividends leading to you owning more stock, which leads to better profits over time. If you hold good quality, dividend paying stocks for decades and reinvest the dividend received yearly, that would finally accumulate into a lot of wealth than you could imagine.

MAKING SENSE OF DIVIDENDS.

When you hear a company announce its annual results and reward its shareholders with a 1000 per cent dividend , doesn’t that look attractive? But don’t get carried away. Companies declare dividends as a percentage of the face value of their shares, which may range from Re 1 to Rs 10. So a 100 per cent dividend on a Re 1 share is only worth Re 1 a share.Not all companies give away a chunk of their hard-earned profits to its investors.Some plough it back into business, to generate greater returns from business in the future. But even after having attained scale capabilities, some capex intensive companies are not known to reward shareholders. For instance, telecom major Bharti Airtel, inspite of operating several years in business, declared its first dividend to its shareholders only in 2009.

What is face value?A company’s capital is subdivided into shares.So if a company’s capital is Rs 10 crore (Rs 100 million), that could be divided into 1 crore shares of Rs 10 each.If the company has divided its capital into shares of Rs 10 each, then Rs 10 is called the face value of the share.

  • When the share is traded in the stock market, however, this value may go up or down depending on demand and supply for the stock. The value of a share in the market at any point of time is called the price of the share or the market value of the share.

So the share with a face value of Rs 10, may be quoted at Rs 55 (market value higher than the face value), or even Rs 9 (market valuelower than the face value). Dividends are always declared on face value.

WHEN IS IT PAID?

Dividends are paid after the board recommendation is accepted by shareholders. So dividend payouts have direct effect on the cash balance of the company.While it is not mandated by the law to sustain dividend payouts, many companies make it a regular process to retain their value among the investor community.Dividends are seen as a harbinger of corporate prosperity, as it is the most popular route taken to reward investors.However, this does not imply that all companies that declare dividends may be on a sound business footing. You may need to run a few litmus tests to find out whether such dividends stand to gloss up your portfolio returns.

Test 1. Dividend Yield.

DY is calculated as the ratio of the annual dividend amount announced and the prevailing market price of the company’s share. The dividend yield ratio shows what investors stand to earn on their shares.

  • For example,  let’s assume that information technology majors Infosys Technologies and Wipro  (whose face value is Rs 5 and Rs 2 respectively) declare their annual dividends, of 270 per cent and 200 per cent respectively. On the face of it, you might think that Infosys is better. But do not go by the mere percentage of dividend announcement since dividends are paid at face value of the stock. That is, for Infosys (face value of Rs 5) the dividend per share is Rs 13.50, whereas for Wipro (face value Rs 2) it is Rs 4.However, the dividend yield will be higher for Wipro (1.2 per cent) as its current market price is lower than that of Infosys (0.8 per cent).

While analysing through high dividend stocks, you will also notice that the companies with high promoter holding declare dividends periodically. Apart from public sector companies, others such as Tata Consultancy Services, Sterlite Industries, Reliance Industries, Wipro and HCL, where promoter holdings are 45-75 per cent, declare dividends regularly.

Test 2- Dividend coverage.

This ratio measures the extent to which a company’s earnings support its dividend payments.The dividend cover ratio tells us how easily a business can pay its dividend from profits. A high dividend cover means that the company can easily afford to pay the dividend and a low value means that the business might have difficulty paying a dividend. Here’s the formula followed by an example.

Dividend cover = Net profit available to equity shareholders
Dividends paid to equity shareholders

BONUS SHARES

Bonus shares have been already  dealt in the previous articles.Bonus shares issued by capitalizing a part of the company’s reserves. Following a bonus issue, though the number of total shares increase, the proportional ownership of shareholders does not change. Also, post the bonus the cum bonus share price should fall in proportion to the bonus issue, thereby making no difference to the personal wealth of the share holder. However,  a bonus is perceived to be a strong signal given out by the company and the consequent demand push for the shares causes the price to move up. As far as tax is concerned, since no money is paid to acquire bonus shares, these have to be valued at nil cost while making calculations for capital gains.

WHY DO COMPANIES ISSUE BONUS SHARES?

  • The issue shares allows the company to declare a dividend without using up the cash that may be used to finance the profitable investment opportunities within the company and thus company can maintain its liquidity position
  • When a company faces stringent cash difficulty and is not in a position to distribute dividend in cash, or where certain restrictions to pay dividend in cash are put under loan agreement, the only way to satisfy the shareholders or to maintain the confidence of the shareholders is the issue of bonus shares.
  • I By issuing bonus shares, the rate of dividend is lowered down and consequently share price in the market is also brought down to a desired range of activity and thus trading activity would increase in the share market. Now small investors may get an opportunity to invest their funds in low priced shares.
  • The cost of issue of bonus shares is the minimum because no underwriting commission, brokerage etc. is to be paid on this type of issue. Existing shareholders are allotted bonus shares in proportion to their present holdings.

More on bonus issues :

1. Bonus shares : A positive sign
2. The difference between Bonus and stock splits.

That’s about Dividend vs Bonus !!

have a nice day ..

You may like these posts:

  1. How is a bonus issue different from a stock split?
  2. Bonus shares – A positive sign.
  3. Benefits of owning shares

3 Responses to “Dividends vs Bonus”

Dating with dividends | Basics of Share Market

November 1, 2011 at 8:17 am

[...] Dividends vs Bonus [...]

well job sìr keep it up

November 4, 2012 at 9:13 pm

good job sir ,,, keep it up

kumar ravi shankar

October 11, 2014 at 7:10 am

nice information for small investors like us. many thanks.

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