If a company has excess earnings and decides to pay a dividend to common shareholders, then an amount is declared along with the date when this would be paid out. Usually, this is determined on a quarterly basis after a company finalizes its income statement and the board of directors meets to review the financials.
- A company's board of directors may opt to pay a dividend to all common shareholders in a process that involves several key steps.
- On the declaration date, the Board of Directors announces the dividend, the size of the dividend, the record date, and the payment date.
- The record date is the day by which you must be on the company’s books as a shareholder so as to receive the declared dividend.
- Buy the stock before the ex-dividend date and you get the dividend; buy it on or after the ex-date, and you don't - the seller of the stock gets it.
- The payment date is when the company pays the declared dividend only to shareholders who own the stock before the ex-date.
How And Why Do Companies Pay Dividends?
How Dividends Are Paid Out
Dividends are usually paid in the form of a dividend check, but they may also be paid in additional shares of stock. The standard practice for payment of dividends is a check that is usually mailed to stockholders a few days after the ex-dividend date, which is the date on which the stock starts trading without the previously declared dividend.
The alternative method of paying dividends is in the form of additional shares of stock. This practice is known as dividend reinvestment and is commonly offered as a dividend reinvestment plan (DRIP) option by individual companies and mutual funds. Dividends are taxable income regardless of the form in which they are paid. Utility companies often pay out dividends rather use the funds for expansion projects.
Key Dividend Dates
If a dividend is declared, shareholders are notified via press release and the information is usually reported through major stock quoting services for easy reference. The key dates that an investor should look for are:
- The date that the dividend is declared called the declaration date.
- At the time of declaration, a record date, or date of record, is set, meaning all shareholders on record on that date are entitled to the dividend payment.
- The day following the record date is called the ex-date or date the stock begins trading ex-dividend. This means that a buyer on ex-date is purchasing shares that are not entitled to receive the most recent dividend payment.
- The payment date follows usually about one month after the record date.
On the payment date, the company deposits the funds for disbursement to shareholders with the Depository Trust Company (DTC). Cash payments are then disbursed by the DTC to brokerage firms around the world where shareholders hold the company's shares. The recipient firms appropriately apply cash dividends to client accounts or process reinvestment transactions as per a client's instructions.
Tax implications for the dividend payments vary depending on the type of dividend declared, account type where the shareholder owns the shares and how long the shareholder has owned the shares. Dividend payments are summarized for each tax year on Form 1099-DIV for tax purposes.
(Read more about the steps involved from announcing a dividend to receiving it in these related articles—Introduction to Dividends and Dissecting Declarations, Ex-Dividends, and Record Dates.)
Once a dividend is declared on the declaration date, the company has a legal responsibility to pay it.
Dividend reinvestment plan, known as DRIP, offers a number of advantages to investors. If the investor prefers to simply add to his or her current equity holdings with any additional funds from dividend payments, automatic dividend reinvestment simplifies this process as opposed to receiving the dividend payment in cash and then using the cash to purchase additional shares. Company-operated DRIPs are usually commission-free since they bypass using a broker. This feature is particularly appealing to small investors since commission fees are proportionately larger for smaller purchases of stock.
Another potential benefit of dividend reinvestment plans is that some companies offer stockholders the option to purchase additional shares in cash at a discount. With a discount from 1-10%, plus the added benefit of not paying commission fees, investors can acquire additional stock holdings at an advantageous price over investors who purchase shares in cash through a brokerage firm.
The Bottom Line
Dividends are a way for companies to distribute profits to shareholders, but not all companies pay dividends. Some keep retained earnings to re-invest for growth opportunities instead. If dividends are paid, a company will declare the amount of the dividend and holders of stock by the ex-date will be paid accordingly on the subsequent payment date. Investors who receive dividends can keep them as cash or re-invest them for accumulate more shares.