The Indian equity market is capable of offering returns to any type of investor. You can find ideal investments if you want to take on more risk for the possibility of better returns, or you can invest in instruments that are low-risk and offer steady returns over time. Investors who want to invest in equities but have a lower risk appetite invest in stocks that offer regular and high dividends.
However, when a company offers dividends to its shareholders, it impacts its stock price, further affecting the investment value of investors wanting to earn through capital appreciation (increase in share price). As most portfolios are a mix of high-risk equities for better returns and low-risk equities for dividend payouts, it is important to know how dividends impact share prices.
Read more: What are equity shares
How can you earn dividends?
Dividends are payments made by public companies that have their shares listed on the stock exchanges. Such companies make dividend payments to their current shareholders, which they distribute when they earn profits. Shareholders receive dividend payouts based on the number of shares they hold. For example, if you hold 10 shares of a company and it has announced Rs. 5 as a dividend per share, you will receive Rs. 50 as dividend payout.
Companies can sometimes also offer stock dividends, in which you receive additional shares equal to the value of the announced dividend amount. Once the shares are in your demat account, you can profit by future dividend payouts paid for these shares or by selling the shares and receiving the cash gains.
Read more: Forfeited share
How does it affect prevailing stock prices?
Dividends have an immense impact on stocks as they influence their prices at every stage. Dividend impact on stock prices starts right from the dividend announcement date, as it sends a positive signal to investors. When a company announces dividends, investors look at the company positively, as it must have earned good profits to be able to distribute dividends.
Here, value investors see the company as a viable investment, thinking that the good fundamentals will positively impact the stock price. On the other hand, risk-averse investors who want to earn through dividends also find the company a viable investment, increasing demand and, ultimately, the stock price.
If a company has earned profits but has retained them for business purposes, it may fail to attract investors as they may feel that the company does not have adequate cash flow to cater to their business needs. In such a case, current shareholders may sell their holdings, and the stock may see limited buying from new investors, resulting in a share price decline.
Furthermore, companies that offer dividends erratically (not regularly) see their stock price decline due to limited demand. Investors find such stocks extremely risky because they feel that the company is not earning consistent profits to distribute dividends or does not have a constant positive cash flow. Shares of such companies generally trade at a lower price on the stock exchanges.
What are the long-term effects?
Companies with a large market capitalisation (large-cap companies) have a reputation for paying high dividends to their shareholders. As they earn substantial profits, they generally offer dividends every year to their shareholders, further increasing stock demand and share price. Most investors invest a large amount in such shares to increase their dividend payouts and earn a steady income with lower risk.
On the other hand, companies with comparatively lower market capitalisation (mid-cap or small-cap companies) do not have substantial earnings. This forces them to use any profit they earn for business purposes such as expansion or debt repayment. If they retain profits for an extended period, investors may deem their shares as non-profitable ventures. This is the main reason for the stocks of mid and small-cap companies trading at a relatively lower price.
If a company pays timely dividends, short-term stock fluctuations are seen between 2 and 3 days from the date of dividend announcement and the ex-dividend date.
Let us take a closer look
There are three dates concerning the dividend payouts:
- Dividend declaration date: The dividend declaration date is when a company announces that it will be paying dividends to the shareholders. Companies announce such news through a press release.
- Record date: The record date is the cutoff date established by a company to determine the shareholders eligible to receive the next dividend payment. Only those listed as shareholders in the company’s records on this date receive the dividend.
- Distribution date: The distribution date is when a company distributes the dividends to the shareholders listed on the company’s records. In the case of cash dividends, shareholders receive the funds directly into their bank accounts.
In case a company has announced stock dividends, the dividend impact on share price is similar to the announcement of cash dividends. Stock dividends also increase the share price and create a positive impact on investors about the company's financial capabilities.
Conclusion
Dividend impact on share price is generally positive as it communicates that the company has earned high profits, making it comfortable to distribute a portion to the shareholders. Understanding dividend impact on stock price plays an important role if you have a low-risk appetite and want to invest in stocks for steady gains based on dividend payouts.
