If you want to invest in companies by buying company shares, you must understand what is a dividend. Through dividends, investors are issued with a portion of the company’s earnings. The dividends can be issued as stock shares, cash payments, or any other arrangement. Companies typically pay dividends based on how many shares a particular shareholder owns in a company. However, there is more to consider for you to understand what is a dividend. This article looks at what is a dividend, how it works, and when companies will or won’t issue dividends.
What Is a Dividend?
A dividend is the distribution of rewards from a portion of the company’s earnings and is usually paid to the shareholders. The dividends are managed and decided by the board of directors of the company although the payments must be approved by the shareholders via their voting rights. A dividend is a corporate earning that a company passes on to the shareholders.
While dividends are issued in cash or stock payments, there are other arrangements that the company can use. For instance, the company could decide on issuing the payments via mutual funds and exchange-traded funds (EFT).
When a corporation makes money, it has an option of sharing the profit proceeds with its shareholders or retains the money as earnings, which can be reinvested back into the company operations. If the company pays dividends to the shareholders, the board of directors decides about what percentage of earnings should be distributed to the shareholders. Even though dividends are typically paid on a quarterly basis, it is not mandatory for companies to do so.
Cash Dividends
If the board of directors of a company decides to issue cash dividends, shareholders holding its stocks receive payments on the basis of the number of shares they own. For instance, if you own 2,000 shares of a company’s stock, and cash dividends are issued in the amount of $10 per share, you’ll be paid $20,000. However, the amount will be taxed immediately.
Stock Dividends
When a company pays the dividends through stock, it is an indicator that the company is low on operating cash but still wants to make the investors happy. However, companies could also offer stock dividends to offer investors more flexibility. A stock dividend is not taxed until the shareholder sells it. Both cash and stock dividends work similarly in that the shareholder gets a certain number of additional shares based on the number of shares he or she already holds. For example, if you hold 1,000 shares of a company and it issues a stock dividend of 5%, you’ll receive 50 extra shares of stock.
How Does It Work?
Breaking It Down
What is a dividend? Now you know, so the next step is learning how it work. The dividend is a token reward that companies pay their shareholders for investing in the company’s equity. It comes from the profit made by the company. Although a major portion of the profits made in a given period time is kept within the retained earnings, the remainder is allocated to the shareholders as dividends. The retained earnings represent the money that the company will use for ongoing and future business activities.
Sometimes, companies can still pay dividends to the shareholders even when they make suitable profits. This is because they want to maintain the track record of making regular dividend payments.
The company’s board of directors issues the dividend payments based on agreed timeframes and payout rates. Different time frames are used by different companies, such as monthly, quarterly, or annually. Most of the big companies like Walmart make quarterly dividend payments. In addition, corporations can also make non-recurring special dividends either individually or in addition to a scheduled dividend.
Dividend Paying Companies
Since we have narrowed down what is a dividend, you should know what companies pay them. Established and larger firms with more predictable profits are the best dividend payers. They typically issue regular dividends to maximize shareholder wealth and trust in ways that are not dependent on normal growth.
Companies belonging to basic materials, oil and gas, healthcare and pharmaceuticals, banks and financial, and utility sectors are more likely to pay dividends regularly. Firms structured as real estate investment trusts (REIT) and master limited partnerships (MLP) are also top dividend payers. Companies may issue regular dividend payments as stated in their investment objectives.
On the other hand, high-growth companies and start-ups are less likely to issue regular dividend payments. This is especially for firms in the biotech and technology sectors. Most of them are in the early stages of development, a phase where they incur high costs and often losses attributed to business expansion, research and development, and operational activities.
Due to these expenses, they may not have enough funds to issue dividend payments to their stakeholders. It is a common trend for early- and mid-stage firms, even when they make profits, to avoid issuing the payments if they aim to grow and expand. They prefer reinvesting the profits.
Dividend Dates
There is a chronological order of events that companies follow to issue dividend payments. The associated dividend payout dates are vital in determining the shareholders who will qualify to receive the payments. The most important dates are the announcement, ex-dividend, record, and payment dates. An investor should take note of these dates so that he or she knows when he or she will receive the dividend payments.
The announcement date is when the company publicizes the dividends, and the date must be approved by the stakeholders prior to being issued. The ex-dividend date is the date on which the dividend eligibility expires. It is also known as the ex-date. For example, if a dividend has an ex-dividend date of January 3, the shareholders who buy the stock on or after the day do not qualify to get the dividends as they are purchasing it on or after the expiry date. If they do before the date, they are eligible to receive payments.
The record date is the cut-off date that the company sets to determine which shareholders are eligible to receive the dividend. Lastly, the payment date is when the company issues the payment of the dividends. The company credits the finds to the accounts of the shareholders.
Impact on Share Price
Dividends are irreversible, which implies that the money leaves the company’s books and accounts forever. This impacts the share price as it rises on the announcement date by the amount of dividend declared and reduces symmetrically at the opening session of the ex-date.
When Companies Will and Won’t Pay Them
Why Companies Will Pay
This occurs when companies keep so much profit that they can reinvest to themselves and still have money left. In this scenario, a company issues the dividends. Many investors appreciate the extra income that dividends offer, and distributing dividend payments makes the company’s stock look more appealing. This attracts more investors as it is a sign that the company is thriving. They also expect continued earnings, leading to more stock purchases.
Why Companies Won’t Pay
A company may not pay dividends as it is still in the process of growing. This means that money is reinvested back to fuel growth. Even established companies can skip the payment and put the money to better use, for example acquiring new assets or funding new investments. Besides, the decision can also be made from a tax perspective. For instance, the capital gain on the sale of appreciated stock can cause a lower and long-term capital gains tax rate at a later date, which means it is better for the investor to wait.
A company may reinvest all the money instead of issuing dividends if it has forecasted high potential expenses of issuing new stocks. To avoid the risk of needing to raise money this way, it is a better decision to keep the earnings. A company may also choose not to pay dividends if it means a reduction of the existing dividends. This is because it could send a negative signal, leading to a decrease in stock price.
Conclusion
When investing, you need to know what is a dividend. Dividends are corporate earnings that a company passes on to the shareholders. It is one method that an investor can earn by buying shares from a company. The dividends are typically issued as cash or stock payments. However, a company could decide using various mutual funds and exchange-traded funds (EFT) to pay the shareholders. The company’s board of directors chooses when and the payout rate of issuing the dividend payments.
Established and larger firms with more predictable profits are the best dividend payers as opposed to high-growth companies and start-ups, where money is reinvested to fuel growth. To know when the payment will arrive, you must note the announcement, ex-dividend, record, and payment dates just to make sure you sign up for the payments before the expiry date.
Dividends affect the share price. The share price rises on the announcement date by the amount of dividend declared and reduces symmetrically at the opening session of the ex-date. We hope that this article has adequately addressed what is a dividend, how it works, and when companies will or won’t issue dividends.