What is a dividend?
Looking for a dividend definition? The distribution of a section of a company’s earnings to its shareholders is known as its dividends. Company dividends are a portion of earnings chosen by the company’s board of directors and can be issued in the form of shares of stock, cash payment or property. When a company earns a profit it's able to put those earnings back into the company (retained profit) and pay the rest to its shareholders. A fixed amount per share is designated to a dividend and shareholders acquiring a dividend in proportion to their shareholding.
Where have you heard of dividends?
Dividends are mainly referred to by the dividend rate or the dividend yield. The dividend rate can be quoted in the form of the dollar amount that each share is allocated, and the dividend yield is quoted as the percent of the current market price. The net profit of a company can be distributed to the shareholders in the form of company dividends, and it can also be reinvested in the company as retained earnings – a company can also choose to do both if it wishes. The repurchasing of a company’s own shares in the open market is also a possibility and is known as a share buyback. Both share dividends and buybacks don't change the principal value of a company’s shares. A dividend can take the form of a one-time special dividend or as an ongoing cash dividend to investors and owners. The form of these payments must be approved by the company’s shareholders.
What do you need to know about dividends...
Company dividends have been used since the 1600s, with the Dutch East India Company being the first public company to pay dividends. Dividend payments can take many forms, with cash being the most common. The list below explains the forms of dividend payment.
These forms of dividends are normally paid out in currency, usually by cheque or electronic funds transfer, and they are usually taxable in the year that they are paid. This is the most usual way of sharing company profits with shareholders. The method for this is that each share owned has a set declared amount of money allocated to it. For example, if a shareholder has 100 shares and the cash dividends are 25 pence a share then the total that the stock holder will be paid is £25. These dividends are not classed as an expense; they are however classed as a deduction of retained earnings.
Stock Dividend Distributions
These are circulations of new shares formed for limited partners by an alliance in the form of additional shares. Nothing is split, but the share dividends add to the total value and market capitalisation of the company as well as minimising the original cost basis per share.
Stock or Scrip Dividends
These are dividend stocks, paid in the form of additional stocks of the issuing company or another corporation (for example, a subsidiary). These dividend stocks are most commonly circulated in proportion to shares owned. Nothing will be gained if the dividend stocks are split – this is because the total amount of shares increase but the value of each share is lowered, without changing the market capitalisation of the held shares.
This particular type of dividend is also known as dividends in specie and they are the sort that are paid out in assets. These types of dividends are actually quite rare and are mainly securities of other issuer owned companies.
These are payments made before a company’s Annual General Meeting and final financial statements. When declared, this dividend usually accompanies the company’s interim finances.
Financial assets with a known value can be shared as dividends (this includes warrants). For major corporations with subsidiaries, dividends can be put into shares of a subsidiary company.
Declared dividends must be approved by the board of directors before they can be paid out. The list below is a brief run down of different types of dividend dates:
Declaration date – these dividend dates are the days that the intention to pay dividends is declared by the board of directors. On this day, a liability is created and recorded on the company’s books. Once that is done, that company officially owes money to its stock holders.
Ex-dividend dates– the day where share dividends are bought and sold and are no longer to be paid. In the U.S, this is normally two days before the record date.
Book closure date – this dividend date is when a company declares a dividend. It will also issue a date where the company will temporarily close its books for a fresh feed of stocks.
In-dividend dates– this is one trading day before the ex-dividend date, where existing stock holders and any buyers of stock on this day will receive dividends and any holders who are selling their stock lose the right to their dividends.
Payment date – the day where the dividends are transferred to the shareholders’ bank accounts or the cheques are mailed out to them.
Record Date – registered shareholders on company files will be paid their dividends on this date. Shareholders who are not registered by this day will not receive payment.
The graph below illustrates the Dow Price/Dividend Ratio History:
There are many reasons why dividends are thought to be positive, the main one being the “Bird in Hand” argument regarding dividend policy. This states that investors are more wary of receiving any capital gains or future growth from retained earnings than they are of receiving current dividend payments. This is due to the idea that investors hold the value of the current dollar they would be certain to receive as higher than that of the reinvested dollar they are expected to receive.
Certain countries treat the money made from dividends at a more positive tax rate than everyday income. Investors wanting tax advantages capital may seek dividend paying stock as a way of reaping the benefits of potentially positive taxation. If a company has a long and favourable history of past dividends payment, the reduction or complete elimination of payable dividends may suggest to an investor that the company is struggling. In contrast, an increase in dividend rate may suggest a positive shift.
Major established companies tend to be the ones who offer more dividend stock as they have an interest in maintaining and growing shareholder wealth in ways other than normal growth. On the other hand, start-ups and high growth companies in the fields of technology or biotechnology very rarely offer dividend stock, as their profits are usually reinvested to help maintain a higher than average level of growth.
Where can you find out more about dividends...
Our glossary has many useful related pages on dividends and the stock market in general. If you are interested in finding out more on dividends then RoxAnn Klugman's book The Dividend Growth Investment Strategy: How to Keep Your Retirement Money Doubling Every Five Years, is a fantastically paced and in-depth place to start.