Dividends are portions of a company’s earnings that it distributes amongst its shareholders. One might reasonably think why a company would readily give money to other people, and the answer to that is that is giving out dividends contains benefits for the company itself. Whenever a company makes a profit, it can either re-invest in itself or distribute it as dividends amongst the shareholders.
At times, large companies still have a lot of money left behind despite re-investing in themselves, or they are so mature and stable, that they need not invest in themselves. Companies then give out dividends to shareholders for two main reasons. Firstly, shareholders usually like the income that comes with dividends, especially cash dividends, and this gives them further incentive to buy even more shares of the company.
Secondly, when a company gives out dividends, it’s seen to be a sign of the company’s strength and the assurance of the company’s management that the company is on the road towards making even more profits, which is why they are freely rewarding their shareholders from their profits.
Some Crucial Dates to Know
Before we go further, there are a few important dates that every investor should know.
- Declaration Date: the date the company declares the dividend
- Record Date: released with the declaration date, and is the date on which you must be registered with the company as a shareholder in order to be paid the dividend,
- Ex-dividend Date: usually a date set 1 or 2 days prior to the record date, and if a person buys shares on or after this date, the dividend will be paid to the seller rather than the buyer.
- Payable Date: the date on which the dividend is actually paid.
Now that we are familiar with what dividends basically are and the motives companies have for giving them let’s see what the different types of dividends are that companies usually give out.
The Cash Dividend
The first, and most popular type of dividend is the cash dividend. There is a set amount of money that a company decides to give out as shares. The total number of shares available then divides the amount that is to be given out, so if for example a company has decided to allot $20 million to dividends and there are ten million shares available, then each share is worth $2. If you own 100 shares, then the value of your dividend will be the value of one share x the number of shares you own, which, in this case, is $200.
Companies usually pay out dividends quarterly, so you will get 4 payments of $50. One thing that you need to know, also, is the important dates related to dividends. When a company pays its dividends, it seems like the value of the company decreases (as it is paying out money), so the value of the shares decreases. This usually happens on the ex-dividend date.
The Stock Dividend
The second type of share is stock dividends, which are issued by companies that may not have a lot of cash available, but still, want to reward their shareholders. These work in a similar fashion to cash dividends.
Some companies, rather than giving out cash, give stocks as dividends. If you own 1000 shares of a certain company X and the company issues as 20% stock dividend, then you will own 20% of 1000, i.e. 200 shares more, making your total ownership 1200 shares. So if Company X had 1 million (1,000,000) shares before, it now has 1.2 million shares (1,200,000), however as the company has not generated more wealth, and if the company was worth $10 million before, it would still be worth the same now, only the value of the shares will be lowered, so your investment amount remains the same.
How Do Stock Dividends Make Money?
The fact is that when the value of the shares is lowered, as in the scenario described above, more investors may end up buying the stock, leading to a small increase in net share values. It is normally accepted that stock dividends are not as useful as cash dividends, but they are usually suitable for those investors who do not require immediate cash. The biggest advantage, however, of stock dividends over cash dividends is that the former are not immediately taxable, making them suitable for people who do not need immediate cash flow.
The basics of dividends have been laid out before you, so we hope now you don’t find the corporate world as daunting as before and you might even be interested in buying a company’s shares to get a taste of this world!