15th of December witnessed an unprecedented event in the Indian Stock Markets. Majesco Ltd, an insurance technology firm, announced a whopping dividend of ₹ 974 per share at a share price of ₹ 972. At the first glance, this seemed like an opportunity to make some money and it was understandable that investors were drooling over it. However, that was not the case, you see, the devil is in the details, and with this piece, we’ll try and find what was going on.
But before that, let’s understand a few concepts.
Announcement of Dividends
Whenever a company declares a dividend on its shares, there is a flock of investors who take advantage of it. These investors start buying the stock to earn the dividend announced. Following the demand-supply law, the share price should go up theoretically by an amount equal to the dividend announced.
However, in reality, the price change may depend on market dynamics.
The increase in the price continues till the ex-dividend date, which is the date up to which if investors buy the shares they will be entitled to the dividends. On the ex-dividend date and after that, since investors are not eligible for the dividends, they are willing to pay lower for the shares as a result of which the price goes down roughly by an amount equal to the dividend.
With this understanding at the back of our minds, let’s come back to Majesco’s stock.
From ₹ 972 on 14th of Dec, the share price went up to ₹ 985.65 on 22nd of December and it plummeted to ₹ 12.20 on the ex-dividend date. In this case, the share price did not go up by an amount equal to the announced dividend but it came down by ₹ 973.45 which is very close to the dividend declared.
Lack of excitement?
Why then did the investors not show enthusiasm to buy the share despite the exorbitant dividend and low stock price?
The answer lies in taxation. Let’s assume an investor had purchased 100 shares of Majesco at ₹ 973 on December 15 and sold them on December 23 (ex-dividend date) for ₹ 12.20 per share. He made a loss of ₹ 960.80 per share in this transaction (See Loss-1).
After some days he will receive the dividend amount of ₹ 974 per share. Since he had bought 100 shares, the total amount he will receive is ₹ 97,400. However, dividend above ₹ 5000 is subject to TDS (Tax Deducted at Source) of 7.5%. Therefore, the TDS per share would be ₹ 73.05. Further, the remaining dividend income will be taxable at the investor’s income tax slab as it is considered a part of income. Let’s assume that the investor’s income falls in the 20% tax rate slab. Then the tax on dividend income per share would be ₹ 180.19. The net profit on the dividend would be ₹ 720.76 per share (See Profit-1).
However, if you look at the entire transaction there is a net loss of ₹ 240.04 per share and of ₹ 24,004 in total. This is the very reason why very less enthusiasm was shown by investors in reaping the illusory benefit of the dividend. It would never have been profitable. Even for someone like me, without any other source of income were to invest in the stock, there would have been a resultant loss of ₹ 59.85 per share (See the table below).
The investors had anticipated a loss on such an investment and that is why the share price of Majesco did not shoot up significantly. However, it plummeted on the ex-dividend date because the investors who bought the share on that date were not entitled to the dividend and hence, unwilling to pay the price equivalent to the price before the dividend was paid.
The piece was written by Shivam Ghule, a co-author at Casereads. We hope you now understand why it is important to look beyond just the dividends offered on a particular stock.
Subscribe to Casereads‘ Newsletter to join the 5000+ community.