Complete Guide To Corporate Finance

AAA

Dividends - Cash Dividends And Dividend Payment

A cash dividend is money paid to stockholders, normally out of the corporation's current earnings or accumulated profits. Not all companies pay a dividend. Usually, the board of directors determines if a dividend is desirable for their particular company based upon various financial and economic factors. Dividends are commonly paid in the form of cash distributions to the shareholders on a monthly, quarterly or yearly basis. All dividends are taxable as income to the recipients.

Dividends are normally paid on a per-share basis. If you own 100 shares of the ABC Corporation, the 100 shares is your basis for dividend distribution. Assume for the moment that ABC Corporation was purchased at $100/share, which implies a $10,000 total investment. Profits at the ABC Corporation were unusually high so the board of directors agrees to pay its shareholder $10 per share annually in the form of a cash dividend. So, as an owner of ABC Corporation for a year, your continued investment in ABC Corp should give us $1,000 in dividend dollars. The annual yield is the total dividend amount ($1,000) divided by the cost of the stock ($10,000) which gives us in percentage terms, 10%. If the 100 shares of ABC Corporation were purchased at $200 per share, the yield would drop to 5%, since 100 shares now cost $20,000, or your original $10,000 only gets you 50 shares instead of 100. If the price of the stock moves higher, then dividend yield drops and vice versa.
The Mechanics of Dividends
Do
dividend-paying stocks make a good overall investment? Dividends are derived from a company's profits, so it is fair to assume that dividends are generally a sign of financial health. From an investment strategy perspective, buying established companies with a history of good dividends adds stability to a portfolio. Your $10,000 investment in ABC Corporation, if held for one year, will be worth $11,000, assuming the stock price after one year is unchanged. Moreover, if ABC Corporation is trading at $90 share a year after you purchased for $100 a share, your total investment after receiving dividends still breaks even ($9,000 stock value + $1,000 in dividends).

Herein lies the appeal to buying stocks with dividends: they help cushion declines in actual stock prices, and they also present an opportunity for stock price appreciation
coupled with the steady stream of income that dividends provide.

This is why many investing legends such as John Bogle, Warren Buffett and Benjamin Graham all espouse the virtues of buying stocks that pay a dividend as a critical part of the investment return of an asset. (Discover the issues that complicate these payouts for investors Dividend Facts You May Not Know.)


Risks to Dividends
During the financial meltdown in 2008-2009, all of the major banks either slashed or eliminated their dividend payouts. These companies were known for consistent, stable dividend payouts each quarter for hundreds of years, yet despite their storied history, the dividends were cut.

The lesson is that dividends are not guaranteed and are subject to macroeconomic as well as company-specific risks. Another potential downside to investing in dividend-paying stocks is that companies that pay dividends are not usually high growth leaders. There are a few exceptions, but high-growth companies usually do not pay dividends to shareholders even if they have significantly outperformed over the vast majority of all stocks over the last five years. Growth companies tend to spend more dollars on research and development, capital expansion, retaining talented employees and/or mergers and acquisitions, which leaves them with little to no money to spend on dividends.

For these companies, all earnings are considered retained earnings and are reinvested back into the company instead of rewarding loyal shareholders.



It is equally important to beware of companies with extraordinarily high yields. As we have learned, if a company's stock price continues to decline, its yield goes up. Many rookie investors get teased into purchasing a stock just on the basis of a potential juicy dividend. However, there is no specific rule of thumb in relation to how much is too much in terms of a dividend payout.

The average dividend yield on the S&P 500 companies that pay a dividend historically fluctuates somewhere between 2-5%, depending on market conditions. In general, it pays to do your homework on stocks yielding more than 8% to find out what is truly going on with the company. Doing this due diligence will help you decipher those companies that are truly in financial shambles from those that are temporarily out of favor and therefore present a good investment. (To read more on this subject, see Why Dividends Matter, How Dividends Work For Investors and 6 Common Misconceptions About Dividends.)

How Companies Pay Dividends

Dividend payouts follow a set procedure. To understand it, first we'll define the following terms:

1. Declaration Date
The declaration date is the day the company's board of directors announces approval of the dividend payment.

2. Ex-Dividend Date
The ex-dividend date is the date on which investors are cut off from receiving a dividend. If, for example, an investor purchases a stock on the ex-dividend date, that investor will not receive the dividend. This date is two business days before the holder-of-record date.

The ex-dividend date is important because from this date forward, new stockholders will not receive the dividend, and the stock price reflects this fact. For example, on and after the ex-dividend date, a stock usually trades at a lower price as the stock price adjusts for the dividend that the new holder will not receive.

3. Holder-of-Record Date
The holder-of-record (owner-of-record) date is the date on which the stockholders who are eligible to receive the dividend are recognized.

(Understanding the dates of the dividend payout process can be tricky. We clear up the confusion in Declaration, Ex-Dividend and Record Date Defined.)

4. Payment Date
Last is the payment date, the date on which the actual dividend is paid out to the stockholders of record.

Example: Dividend Payment
Suppose Newco would like to pay a dividend to its shareholders. The company would proceed as follows:

1. On Jan. 28, the company declares it will pay its regular dividend of $0.30 per share to holders of record as of Feb. 27, with payment on Mar. 17.
2. The ex-dividend date is Feb. 23 (usually four days before of the holder-of-record date). As of Feb. 23, new buyers do not have a right to the dividend.
3. At the close of business on Feb. 27, all holders of Newco's stock are recorded, and those holders will receive the dividend.
4. On Mar. 17, the payment date, Newco mails the dividend checks to the holders of record.

Dividend Policy
Related Articles
  1. Investing

    How To Calculate Minority Interest

    Minority interest calculations require the use of minority shareholders’ percentage ownership of a subsidiary, after controlling interest is acquired.
  2. Fundamental Analysis

    Is India the Next Emerging Markets Superstar?

    With a shift towards manufacturing and services, India could be the next emerging market superstar. Here, we provide a detailed breakdown of its GDP.
  3. Term

    Estimating with Subjective Probability

    Subjective probability is someone’s estimation that an event will occur.
  4. Economics

    Explaining Replacement Cost

    The replacement cost is the cost you’d have to pay to replace an asset with a similar asset at the present time and value.
  5. Economics

    How Does National Income Accounting Work?

    National income accounting is an economic term describing the system used by a country to gather data and determine aggregate economic activity.
  6. Investing Basics

    Understanding the Modigliani-Miller Theorem

    The Modigliani-Miller (M&M) theorem is used in financial and economic studies to analyze the value of a firm, such as a business or a corporation.
  7. Economics

    Explaining Kurtosis

    Kurtosis describes the distribution of data around an average.
  8. Personal Finance

    Simple Interest Loans: Do They Exist?

    Yes, they do. Here is what they are – and how to use them to your advantage.
  9. Options & Futures

    An Introduction To Value at Risk (VAR)

    Volatility is not the only way to measure risk. Learn about the "new science of risk management".
  10. Investing

    What Rising Volatility Means for Momentum

    After remaining torpid for most of the year, equity market volatility is once again rising.
RELATED TERMS
  1. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  2. Discount Bond

    A bond that is issued for less than its par (or face) value, ...
  3. Surplus

    The amount of an asset or resource that exceeds the portion that ...
  4. Cash Flow

    The net amount of cash and cash-equivalents moving into and out ...
  5. Days Sales Of Inventory - DSI

    A financial measure of a company's performance that gives investors ...
  6. Asset Turnover Ratio

    The amount of sales generated for every dollar's worth of assets ...
RELATED FAQS
  1. What should I study in school to prepare for a career in corporate finance?

    Depending on which area you want to specialize in, corporate finance can be one of the most competitive fields in business. ... Read Full Answer >>
  2. Why would a company issue preference shares instead of common shares?

    Preference shares, or preferred stock, act as a hybrid between common shares and bond issues. As with any produced good or ... Read Full Answer >>
  3. What is the difference between cost of debt capital and cost of equity?

    In corporate finance, capital – the money a business uses to fund operations – comes from two sources: debt and equity. While ... Read Full Answer >>
  4. What is the difference between gross profit, operating profit and net income?

    The terms profit and income are often used interchangeably in day-to-day life. In corporate finance, however, these terms ... Read Full Answer >>
  5. Can I use my IRA to pay for my college loans?

    If you are older than 59.5 and have been contributing to your IRA for more than five years, you may withdraw funds to pay ... Read Full Answer >>
  6. Can I use my 401(k) to pay for my college loans?

    If you are over 59.5, or separate from your plan-sponsoring employer after age 55, you are free to use your 401(k) to pay ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!