What Are Dividend Stocks? How They Work and Their Types
2 June, 2025
Synopsis
Dividend stocks are shares of companies that regularly pay dividends to their shareholders.
They may provide a steady income stream and support long-term wealth creation.
Metrics like dividend yield and payout ratio help evaluate income potential and sustainability.
Investors looking for a steady source of income may often turn to dividend stocks. These are shares of companies that return a portion of their profits to shareholders at regular intervals, usually in the form of dividends. Whether you’re new to investing or a seasoned portfolio builder, understanding how dividends work can help you make smarter, income-oriented investment choices.
What is the Meaning of Dividend?
A dividend is a payout made by a company to its shareholders from its profits or reserves. This reward reflects the company’s willingness to share its earnings with investors. Typically, dividends are paid in cash, but some companies also issue stock dividends, giving additional shares instead of cash.
Stable and consistent dividend payments often reflect strong fundamentals, robust cash flow and management's confidence in the business.
How Dividend Stocks Work?
When a dividend is declared, the company announces the amount and date on which it will distribute the payment. This sets off a series of key dates for investors:
Declaration Date: The date the company announces the dividend.
Ex-Dividend Date: To be eligible for the dividend, you must own the stock before this date.
Record Date: The company checks its records to confirm eligible shareholders.
Payment Date: The actual day the dividend is credited to your account.
Owning dividend stocks is not just about the payout. They also offer dividend income, potential for capital appreciation and a buffer against market volatility.
Types of Dividends
Companies can distribute dividends in several forms:
Cash Dividends
The most common type, where you receive a specific cash amount per share. The dividend is paid on a per-share basis and may be transferred to your bank account or brokerage account on a quarterly or annual basis.
Example: If you own 100 shares of a company and the company declares a cash dividend of ₹10, you will receive ₹1,000.
Stock Dividends
The company issues additional shares instead of cash. Stock dividends are usually issued as a percentage of the shares you own. Here, your total number of shares you own will increase. There is no change in the overall value of the investment.
Example: You own 200 shares (₹100 per share price) of a company that announces a 10% stock dividend. Which means you will receive (200 x 10%) = 20 shares, and the total shares after the dividend will be 220 shares.
Now, the total investment before dividends will be ₹20,000. After receiving the dividend, the share price will be adjusted to 220 shares, i.e., 20,000 / 220 = ₹91 per share.
Special Dividends
This is a one-off non-recurring type of payment given when companies have surplus profits. These dividends are not part of the regular dividend policy.
Example: A company sells a business unit and earns a large profit of ₹500 Crore. The company decides to reward shareholders with a special dividend. The total number of shares the company has issued is 10 Crore, and the company declares a special dividend of ₹5 per share. If you own 1,000 shares, you will earn ₹5,000 as a special dividend.
Interim vs Final Dividends
Interim dividends are paid during the year, while final dividends are declared at year-end after earnings have been finalised.
Example: A company declares an interim dividend of ₹4 per share in Q2, with a final dividend decision pending year-end performance. After a profitable year, a company declares a ₹6 final dividend per share.
Dividend Income Calculation
The formula for calculating dividend income is:
Dividend Income = Dividend Per Share × Number of Shares Owned
For instance, if you own 200 shares of a company that pays ₹5 per share annually, your dividend income would be ₹1,000 per year.
Dividend Yield vs Dividend Payout Ratio
While both are important, they offer different insights:
Dividend yield tells you how much cash flow you're earning from the stock as a percentage of its price. It’s useful for comparing income potential across stocks.
Dividend yield = (Dividend per share ÷ Share price) × 100
Dividend payout ratio shows how much of a company’s earnings are being returned to shareholders, offering clues on sustainability.
Dividend payout ratio = (Total dividends ÷ Net income) × 100
A high yield with a low payout ratio is often preferred, indicating good returns without compromising future growth.
Function of Dividends in an Investment Portfolio
Dividends serve several purposes:
Provide passive income to investors, especially retirees.
Offer stability in volatile markets as dividend-paying companies tend to be mature and less speculative.
Enhance total returns when reinvested using dividend reinvestment plans (DRIPs).
Impact of Dividend on Share Prices
Stock prices usually adjust to reflect dividend declarations. On the ex-dividend date, the stock price typically drops by the amount of the dividend to reflect that new buyers will not receive the upcoming payout.
For example, if a stock trading at ₹500 announces a ₹10 dividend, its price may fall to around ₹490 on the ex-dividend date.
However, consistent and growing dividends may often drive long-term price appreciation due to positive investor perception.
Invest in Dividend Stocks With Ease
Understanding dividend stocks is key to building a balanced and income-generating portfolio. While price appreciation is a major goal, dividend income provides a reliable stream of cash flow and can enhance overall returns when reinvested.
By focusing on stable companies with strong fundamentals and consistent dividend payout records, investors can achieve both growth and income—two cornerstones of long-term wealth creation.
Invest in dividend-paying stocks with HDFC Bank’s 2-in-1 Demat Account. Build a portfolio that generates regular income and long-term growth.
FAQs
What is the ex-dividend date?
It is the cut-off date to be eligible for the declared dividend. You must purchase the stock before this date to receive the payout.
Why do companies pay dividends?
Dividends reward shareholders and may sometimes signal financial strength. They also attract investors who prefer stable returns.
Are dividends taxed?
In India, dividends are added to the investor’s income and taxed as per the applicable slab rates.
Open a Demat Account online
*Disclaimer: Terms and conditions apply. This is an information communication from HDFC Bank and should not be considered as a suggestion for investment. Investments in securities market are subject to market risks, read all the related documents carefully before investing.
