There are two ways to make money on stock investments: capital gains and dividends. Dividend can be distributed in the form of cash or stock. Both type of payments are distributed our of companies profit by reducing retained earning.
Dividends can provide steady periodic income, while capital gain requires action to convert share to cash.
When an investor sells share of a particular company for more than the original purchased amount, the difference between the purchased and sales value is known as the Capital Gain.
For instance, when you buy share/stock of a company for Rs. 100 and subsequently sell it for Rs. 500, you realize a capital gain of Rs 400 (i.e. 500-100).
Capital gain arises only when you sell the company’s stock. When stock/share price rise from Rs 100 to Rs 200, you as an owner of the stock gets only the ability to sell for Rs 100 profit. This means, you will not have capital gain until you sold your investment for a profit.
In India, from income tax point of view, capital gain is either known as long term or short term capital gain.
Capital gains are considered short term if the asset is owned for less than a year. Asset owned or held for more than a year is considered as long term capital gain. Tax calculation is also different.
Apart from this capital gain amount, you may have received certain periodic income from the stock issuing company based on the dividend declared.
Stock issuing companies generally declares dividend based on its profit. For instance, if your stock issuing company before selling the share declare a dividend of Rs 2 per share then based on the number of shares you are holding on the cut off date, you will get dividend paid to your bank account.
Generally companies make their dividend payments on a quarterly basis. The amount and timing of dividend payments are decided by the company’s board of directors. There is no law in India that states a company must pay a dividend, even if the company is profitable.
The value of ownership in a stock declines after receiving dividend from the stock issuing company.
Let’s assume you own one share of XYZ Limited. The stock of XYZ Limited is currently worth Rs 150, and the company pays Rs 50 as dividend per share.
After receiving the dividend amount, the price of XYZ Limited’s share would be around Rs 100. This means, your principal falls to Rs 100 after receiving dividend income of Rs 50.
In simple term, dividends are paid out of profits of the company to the shareholders, where as capital gain occurs when the owner of the share/stock sold his or her holdings in the company for a higher price than the original purchase price.