What is meant by dividend capitalization?

Capitalized Dividends are dividends due on the Preferred Shares which are capitalized by adding them to the Stated price of the Preferred Shares.

As most closely held companies do not pay dividends, to determine dividend capitalization, the evaluators must first find out the dividend paying capacity of the business. The Dividend paying capability of a company is based on the average net income and the average cash flow. To calculate dividend paying capacity, debt repayment, expansion plans, operation cushion, dividend paying history of a business contractual requirements, past and dividends of a comparable company should be analyzed, among others.

After analyzing the above-mentioned factors, the percentage of average net income and of average cash flow that can paid as dividends are estimated. The company should also determine the dividend yield, that can best be determined by analyzing various comparable companies. Like the price earnings ratio method, the results of dividend capitalization produce subjective results.

How to Calculate Dividend Capitalization

In case a business sees a net profit, the profit is usually distributed among shareholders. The company can also retain a part of the earnings to invest in further development of the business. Rather than paying a cash dividend, stockholders of the company will then receive a small stock dividend, which gives more equity to them. Thus, the capitalization of dividends is a measure that shows this new stock as a percentage of the company's total existing outstanding amount in stocks.

Note − In case of retained earnings, the company withholds a portion of net profit without distributing it to shareholders. 

Following are the steps one can follow to calculate dividend capitalization −

  • Step 1 − Divide the earnings that the company retains by the value of a single stock share. For example, if a company whose stock sells at INR 20 per share retains INR 10,000 in earnings, then divide INR 10,000 by 20 to get 500 new shares of stock.

  • Step 2 − Divide the total numbers of shares in the stock dividend by the total number of outstanding shares. For example, if an investor already owns 5,000 shares of the company, divide 500 by 5,000 to get 0.10.

  • Step 3 − Finally, we have to multiply this result by an amount of 100 to get the percentage. With this example, multiplying 0.10 by 100 to get 10. So the company in this case has 10% capitalization of dividends.

Updated on: 17-Sep-2021

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