What is Equity Income?

Equity investment can provide a return in two ways - capital appreciation and dividend income. While capital appreciation refers to an increase in the market value of equity shares, a dividend refers to the distribution of profits by a company to its shareholders. Equity income is also known as dividend income. This blog post is a detailed explanation of equity income.

Equity Income

Profit-making companies can either reinvest their profits or distribute them amongst their shareholders. Companies in their growth phase tend to plough back their profits. However, mature companies with limited investment opportunities usually pay dividends as a way of reward to their investors for investing in their business. It is worth noting that dividends on equity shares are never guaranteed, but are paid at the discretion of the company.

Companies paying equity income are usually well-established with have a history of paying dividends. This creates a constructive obligation on them to continue distributing profits. The stocks of dividend income paying companies tend to be value stocks which trade at levels below their fundamentals.

For example, say Company N made a net profit of INR 25 lacs in the previous financial year. It plans to increase its marketing efforts and hence, chooses to reinvest INR 20 lacs of that money in the business. It had sufficient funds in cash and decided to distribute the balance of INR 5 lacs to its shareholders by way of equity income.

Unlike interest to debt holders, dividends to equity holders are not an expense to a company. They are simply a distribution of the company’s excess profits to its investors. Hence, paying dividends does not reduce a company’s taxable income.

Equity Income Investing

Equity income is one of the sources through which one can make passive income. Investors buying equity income stocks tend to hold them for a longer-term, mainly because it provides them with a constant cash income.

Also, dividends are usually paid out by well-established companies. Hence, equity income investing is ideal for moderately conservative investors.

Investors wanting to earn a regular income can also consider putting their money in a dividend yield fund’. It is a type of mutual fund which invests heavily in equity shares that provide regular dividends. However, the dividends are not guaranteed and are subject to market risk.

Example

ITC Ltd., the Indian conglomerate with a diversified business presence across sectors like FMCG, hospitality, software and packaging has paid dividends 23 times since 2001. For the financial year ending March 2021, ITC declared an equity dividend of 1075.00% amounting to INR 10.75 per share.