Introduction To Dividends: Terms To Know And Other Basics
Cash payments made to stockholders, paid on a per share basis, quoted as a dollar amount or as a percentage of the current market value. Cash dividends are typically paid out of the company's current earnings or accumulated profits.
Date Of Record
The date the company uses to determine its shareholders or "holders of record."
The date a company's Board of Directors announces an upcoming dividend.
A distribution of a portion of a company's earnings paid to its eligible shareholders. Dividends can be in the form of cash, stock and property.
Dividend Coverage Ratio
The ratio between a company's earnings and its net dividend to shareholders. This ratio helps investors measure if a company's earnings are sufficient to cover its dividend obligations. Dividend coverage is calculated by dividing earnings per share by the dividend per share.
Dividend Reinvestment Plan (DRIP)
A plan offered by certain dividend-paying corporations that allows you to automatically reinvest cash dividends by purchasing additional shares of stock on the dividend payment date.
A financial ratio that illustrates how much a company pays out in dividends each year relative to its share price. It is calculated by dividing the annual dividend per share by the current price of the stock.
The date on or after which a stock is traded without a previously declared dividend.
A special dividend paid in addition to regular cash dividends.
The date a declared dividend is scheduled to be paid.
Any person, company or institution that owns at least one share in a company. Also called stockholder.
Stock dividends are dividends in the form of additional shares of stock instead of cash.
Companies that earn a profit can:
- Reinvest the profits through expansion, debt reduction and/or share repurchases; or
- Pay a portion of the profits to shareholders; or
- Both reinvest and payout to shareholders.
Dividends are normally quoted on a per share basis, meaning that the dividend each shareholder receives is based on the number of shares that he or she owns. For example, if you own 100 shares of stock in company XYZ and the company decides to pay an annual dividend of $5 per share, your dividend would be $500 (100 shares x $5 per share). Dividends can also be quoted in terms of a percent of the current market price; for example, the company may announce a 2.5% dividend. The dividend will be equal to 2.5% of the current stock price. Each eligible shareholder's dividend will be that figure multiplied by the number of shares currently held by the shareholder. For example, assume stock XYZ is currently trading at $50 per share and the company offers a 5% dividend. The dividend would be $2.50 per share (.05 dividend x $50 share price).
A stock's dividend yield is the expected yearly dividend divided by the current stock price:
|Figure 1: How to calculate a stock\'s dividend yield.|
For example, assume stock XYZ is trading at $50 per share and the company offers an annual dividend of $5 per share. The dividend yield would be 10% ($5 dividend ÷ $50 share price). Note that if the stock is trading at a higher price, say $100, the dividend yield decreases ($5 dividend ÷ $100 share price = 5% dividend yield). Conversely, if the stock is trading at a lower price, such as $25, the dividend yield increases ($5 dividend ÷ $25 share price = 20% dividend yield). [Please note, these figures are for illustrative purposes only; a 20% dividend yield would be uncommon (and cause for further research).]
It is easy to become enamored with companies offering high dividends; however, keep in mind that these impressive figures might not represent a stable investment. High dividend yields are frequently indicators of low future growth prospects. A very high dividend yield might be a flag that the company is facing financial difficulty and that the market expects it to be accompanied by cuts to future dividends. Stocks with a low dividend yield, on the other hand, often indicate an expectation of high future growth. The historical average dividend yield for dividend-paying S&P 500 stocks has been between 2 and 5%.
Cash Dividends, Stock Dividends and One-Time Dividends
Cash dividends are what we normally think about when referring to dividends. These are cash payments made to stockholders, paid on a per share basis, quoted as a dollar amount (such as $5 per share) or as a percentage of the current market value (for example, a 2.5% dividend). Cash dividends are typically paid out of the company's current earnings or accumulated profits. Often, investors are able to reinvest the dividends to purchase additional shares of stock.
Stock dividends are in the form of additional shares of stock instead of cash. The number of additional shares you receive depends on the number of shares you currently own. For example, a company may issue a stock dividend equal to five shares of stock for every 100 owned by each shareholder. If you have 500 shares, you would receive 25 shares. The price of the stock will likely respond to the dividend so that shareholders' post-dividend wealth remains the same. The stock dividend increases the number of shares each stockholder owns but does not necessarily have an immediate effect on the overall value of each stockholder's shares.
A company may also pay a special one-time dividend in addition to its regular cash dividends. A company may pay a one-time dividend for a variety of reasons, such as a sudden increase in cash resulting from the sale of a business or substantial litigation winnings. During the last quarter of 2012, with the "fiscal cliff" approaching in the U.S., many companies issued one-time dividends in anticipation of the higher dividend tax rates presumed to go into effect starting Jan. 1, 2013.
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