What is a Cash Dividend?
Cash dividend is that portion of profit which is declared by the board of directors to be paid as dividends to the shareholders of the company in return to their investments done in the company and then discharging such dividend payment liability by paying cash or through bank transfer.
In simple words, it is a return (money) paid to the shareholders for the investment made in the shares of the organization. It is considered a reward to the investors after considering the future prospects of the firm.
The cash dividend is paid out of the Net Profits made by the firm during the Financial Year. It is not mandatory for a company to the declared dividends and instead, the amount can be plowed back for other developmental activities of the company. However, most of the established firms declare the dividends on a yearly or once in two years for keeping the investors interested. The cash dividend is paid on a per-share basis.
Cash Dividend Chronology
There are some important dates which should be known around this concept of cash dividends
- Declaration Date: The day when the Board of Directors of a company announce approval of dividend payment.
- Holder of Record Date: Record date of Dividend is the day on which eligible stockholders are recognized.
- Ex-Dividend Date: Ex-Dividend Date is whereby investors are cut-off from receiving a dividend. It is normally 2 days prior to the holder of the record date. This date is very important because new shareholders are not eligible for dividend from this date onwards.
This is because the stock price tends to fall due to cash dividend payments.
- Cum Dividend Date: Time period when dividend has been declared by the firm but not paid. Stocks trade cum-dividend till the ex-dividend date.
- Payment Date: The date on the actual dividend is paid to the stockholders of record. In case of the interim dividend, pay-out happens within 30 days from the announcement date of dividend but for the final dividend, payment has to be made within 30 days of the AGM (Annual General Meeting).
Cash Dividend Example
Let us assume PQR Company had substantially high profits for the current financial year and decided to distribute dividends to all its shareholders. Mr ‘C’ owns 150 shares bought at $15 per share which makes his total investment of $2,250.
If the firm declares a cash dividend of $0.50 per share, Mr ‘C’ gets a total dividend of $75 ($150*$0.50). The yield on the same:
Total Dividend/Cost of the Stock = $75/$2,250
= 3.33%
Let us understand the functioning of dates through cash dividend example:
- On March 28, PQR company declares paying the regular cash dividend of $0.5 per share. It further mentions the holder of record date shall be April 27 and the payment date of May 20.
- The ex-dividend date will be April 25 indicating any new shareholders hereon are not eligible for the dividend. It covers up the T+2 aspect.
- The time frame between March 28 and April 24 is when the shares are trading cum dividend. If any new shareholder joins till April 24, they are eligible for a dividend facility.
- May 20 is the payment date on which PQR will dispatch the cheques to holders of record.
Extending the above example, the cash dividend also has an inverse impact on the share prices. The stock price will generally fall post dividend declaration since it’s a fall in the equity value of the business.
Let’s say if the price of the above stock was trading at $12 prior to the event and it the following date, it falls to $11.50. Assuming Mr ‘C’ retains all the shares and there is no change in the Nominal value:
- The market value of the shares prior to the event = $12*150 (shares) = $1,800
- Market Value post the event = $11.50*150 = $1,725
As calculated above, the cash dividend received was $75 and the value of shares post the event was $1,725. When combined it takes the total value to $1,800 ($1,725 + $75) which was the value of shares prior to the event of this dividend. This implies that the share value decreases roughly around the same amount as the cash dividend.
Importance of Cash Dividend
There are multiple factors that impact the size and timings of dividends especially in the aftermath of the 2008-09 Global Financial crisis.
- Firms may distribute cash dividends to maintain specific financial ratios or manage any cyclical tendencies of the firm. Let’s assume a firm is selling Air-Conditioner’s which have high demand during the summer season. They may declare a dividend during the winter season which will help to maintain share prices. It is during the winter season the demand for such product dries up and stock prices can tank.
- Firms in their maturity stage tend to pay regular dividends as compared to the fast-growing firms as they are focussed on re-investing the cash for the growth of the business.
- Companies do not always pay dividends in cash and may pay stock dividends. The shareholders may also be given a choice between cash and stock or permit the shareholders to buy additional shares with this dividend (dividend reinvestment plan).
- Dividend yields display the overall sentiment of the market. Market experts observe the trend of cash dividend provided and thus observations are made accordingly over a period of time including periods of distress.
- The taxation laws of the respective country are to be considered before the declaration. Laws keep changing regularly and thus companies are required to adhere to them. Generally, firms have to pay DDT (Dividend distribution tax) before distributing the same to the stockholders.
Conclusion
The aspect of Dividend is considered a double-edged sword. On one hand, providing the cash dividend to the shareholders does boost the confidence of investors. On the flip side, it involves financial resources foregone, which could have been utilized for future developmental activities of the firm.
The stock market also may react accordingly. Initially, it may point southwards to the overall stock prices, but if a firm is known for distributing cash dividends, the stock prices may remain stable or rise to give a boost to the stock market.
Hence, the decision on dividends has to be made keeping in view the future positioning of the firm and the industry expectations it has set up. One should understand that Capital requirements and investor expectations vary from one industry to another and thus comparison of cash dividends and dividend payout ratio should be compared amongst similar companies/industry.
Cash Dividend Video
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