In my Instagram page @nepsetrader, I’ve been getting the same question from multiple folks multiple times. Keep your peace, my friend. I will make everything clear in this quick blog post.
So you’ve been seeing news about companies distributing dividends in percentage. The latest dividend was announced by Mahalaxmi Bikas Bank Limited (ticker symbol MLBL). MLBL has proposed a 9.26% dividend for the fiscal year 2076/77. The company has proposed 9% bonus shares and a 0.26% cash dividend for tax purposes.
What does that actually mean?
Let us breakdown MLBL’s dividend announcement part by part.
1) 9.26% Total Dividend
The thing about a percentage value is that it is a part of something. When we say our body contains 60% water, we know that we are comparing the water content of our body. 60% in itself means nothing. 60% of our body is what we are comparing here.
Similarly, when we say that the apple is 50% rotten, we are actually talking about the apple, half of which is rotten. Sounds simple but this is what most people don’t understand about a stock dividend.
So, when MLBL has proposed a 9.26% dividend, it is distributing 9.26% of what?
It is distributing 9.26% of the paid-up capital. Paid-up capital is the amount of money a company has received from shareholders in exchange for shares of stock. Paid-up capital is created when a company sells its shares on the primary market directly to investors, usually through an initial public offering (IPO).
Why does a company have to distribute its dividend in percentage? To distribute the profit of the company in equal proportion. Investors will have invested different sums of money in the company. The percentage calculation ensures that people who invest more get a proportionately higher amount of profit returns and investors who invest less will get smaller profit returns, but in the same proportion.
Are you with me? Note that although the dividend is actually distributed from the company’s profits, the dividend calculation is done in the paid-up capital. The dividend amount is always a certain percentage of the company’s total paid-up capital.
2) 9.26% Total Dividend for the fiscal year 2076/77
When I first learned about the Nepali fiscal system, I was as confused as you might be right now. Why are they including two years at the same time? Why are they saying 2076 and 2077 at the same time?
Well, it turns out the business year (fiscal year) does not start at Baisakh like the normal calendar years. It turns out that a fiscal year in Nepal actually starts in Shrawan and ends in Ashad of next year. Don’t ask me why they do this. As of writing this, I simply do not know. I don’t memorize facts that do not make me money. Haha.
Anyways, the fiscal year 2076/77 means that we are talking about the fiscal year that started in Shrawan of 2076 BS and ended in Ashad of 2077 BS. A company distributes the dividend from the profit of the past year. Since we are now in the fiscal year 2077/78, MLBL has distributed the 9.26% dividend from the profit of the previous fiscal year, i.e. FY 2076/77.
3) 9% bonus shares and 0.26% cash dividend
So we know that MLBL has distributed a 9.26% total dividend from the paid-up capital. 9% dividend is proposed as bonus shares and 0.26% as a cash dividend.
To make things easier, let us first talk about cash dividend
In theory, cash dividend distribution sounds simple. Basically, the company is distributing a portion of its profit in pure cash. You invest in the company (buy its shares) for a profit. There is no other reason. People enter the stock market to make money.
So, if a company you invest in makes a good profit, you definitely expect a portion of this profit. The company rewards you for investing in them by giving you some of its profit as cash. So, let us say a company has a stock price of Rs. 500 and it distributes a 50% cash dividend. Then, by basic maths, you should get Rs. 250 extra cash as a cash dividend, right?
This is why cash dividend distribution sounds simple but it isn’t. This is also what confuses most beginners in the stock market. A cash dividend is not distributed on the stock price of a company. It is actually distributed in the par value. Remember that you paid Rs. 100 per share for companies in an IPO? That is the par value of the company.
While writing this article, MLBL has a share price of Rs. 285 per share. However, you will get the cash dividend on the par value, i.e. at Rs. 100 per share. So, for every share you have of MLBL, you will get Rs. 0.26 cash dividend. Most companies in NEPSE have a par value of Rs. 100.
There is another “but” in the story of MLBL. You guessed it, 0.26% cash dividend is pretty low. On top of it, you will not get this cash dividend to go eat ice cream with your friend. Notice the last part of this statement:
“The company has proposed 9% bonus shares and a 0.26% cash dividend for tax purposes.”
Did anyone say tax? You’re right. This cash dividend will actually be used to pay for the tax that you need to pay for getting the bonus shares. Now, let us now learn what these bonus shares mean.
Let us now talk about bonus shares
A company does not distribute all of its dividends in cash. If an IT company distributed all its profit to investors, how will it pay for employees? How will it buy new computers and pay for rent and electricity?
This is why the company keeps some of its profit to reinvest in new ventures and scale its business. And, to assure investors that their profit is reinvested in the company, a company gives them an extra “bonus” shares.
Pretty smooth, right?
For simplicity, you may calculate bonus shares in the number of shares of the company that you own. MLBL has distributed 9% bonus shares. If you have 100 shares of MLBL, the company will give you 9 extra shares and you will have a total of 109 shares of MLBL.
The previous 0.26% cash dividend will be used for the tax to get these bonus shares. Remember, you can sell the extra shares at whatever the market price is of MLBL after the bonus shares are listed. This will make you richer! And whenever you earn as a citizen of Nepal, you’ve gotta pay some tax to the government, man! That’s the rule!
That’s cool! Also, I’ve heard things about the “book closure date.” What is that now?
Hmm. Right. You can buy the shares of MLBL after it has proposed its dividend and still be eligible to get the dividend. How cool is that?
While writing this, MLBL hasn’t declared its book closure date. Thus, I can buy its shares tomorrow when the stock market opens and still get the dividend. I do not have to invest in the company for one whole fiscal year!
The book closure date is simply the date on which the company closes its books for the dividend. Investors can still buy the shares of MLBL after that date but they won’t get the dividend. To get this 9.26% dividend of MLBL, you must buy the shares of MLBL before the book closure date and you must not sell those shares till the book closure date.
A common question I get is, what will happen if I sell the shares the next day after the book closure date?
You can sell the shares after the book closure date whenever you like and you will still get the dividend. Do you get me? Read it again if you did not.
Nice. Anything else I should know?
Yes. There are a lot of things you should know.
For example, it sounds so smart to buy the shares of a company only after it proposes its dividend. Why invest for one whole year if you can buy after the company announces its dividend? I mean, we can only invest if it gives a good dividend or we can leave the company if it distributes a very little dividend, right?
Well, it’s not that simple as it sounds. In the stock market, you can profit in two ways:
1) Invest and profit by the dividend that the company distributes (Dividend gain), or,
2) buy shares at a cheap price and sell the same shares when the price rises (Price appreciation gain).
If a company announces a pretty good dividend, investors rush to buy it, which drives the stock price higher. So, if you buy after a company proposes a good dividend, you will get the dividend gain but you can’t profit a lot from the price appreciation. This is because the stock is already expensive when you buy it!
There are also other things to keep in mind when considering stocks and their dividend. However, everything we talked about in this article should be enough for now. Other things will be clear once you also become a player in the market. I will be updating this blog if I get additional queries that will be meaningful to a beginner.