There are four kinds of dividends: regular, extra, special and stock dividends. All dividends are declared by a company's board of directors, based on the financial performance and management strategy of the enterprise. The stock of a company that pays dividends is referred to as a dividend-paying stock. The percentage represented by the total of the annual dividend payments on a stock, relative to the stock price, is called the dividend yield.
Types of Dividends
A regular dividend is a dividend payment the company expects to maintain for the foreseeable future. Most regular dividends are paid quarterly, but some companies pay semi-annually or annually. An extra dividend is an additional amount that may or may not continue to be paid in the foreseeable future. A special dividend is a one-time distribution of a windfall profit or other special financial event. A stock dividend is issued on a non-regular basis for various strategic reasons. It increases the number of shares outstanding, and reduces the dollar price of the stock.
When a company's board of directors declares a dividend, the date the dividend is announced is known as the declaration date. They also declare the date-of-record and the payment date. The date-of-record, also called the record date, is the date by which you must own the stock to be eligible to receive the dividend. If you have recently bought the stock, your transaction must settle on or before the record date. The most important date to consider when buying or selling a dividend-paying stock is the ex-dividend date, also called the ex-div date. The exchange on which the stock trades sets this date as the first date the stock trades without the eligibility to receive the recently declared dividend. On that date, the exchange reduces the stock price and limit orders by the value of the dividend. Purchases of the stock on the ex-div date will not settle in time for the buyers to be owners of the stock on the record date. The payment date is the date the dividend is actually paid to the shareholders.
Most stock price quote systems list the current dividend yield. If you want to figure it yourself, divide the dividend payment per share by the per share stock price. This will give you a percentage, which is the dividend yield. When the marketplace worries about the economy, stock dividend yields tend to be higher than yields on high-quality bonds, because the risk of financial crisis is higher. When the economy is robust, stock dividend yields tend to decline relative to bond yields.
Why Companies Pay Dividends
There are three main reasons for a company to pay dividends. The first reason is to attract buyers of the stock. Another reason to pay a dividend is to reduce the amount of cash the company holds. A company with a large cash balance is vulnerable to a hostile takeover by leveraged buyout. A third reason to pay a dividend is cash management efficiency. The theory behind this reason states that managers are less efficient in their management if they have unlimited funds available.
Why Investors Buy Dividend Stock
Dividends can be a good source of income. Dividend income is not normally taxed at the same rate as regular income, but this tax advantage has changed from time to time so it is always best to check the current tax treatment. Investors also like dividend-paying stock because the payment of dividends tends to shield the stock price from market volatility that affects non-dividend-paying stocks. When interest rates rise, however, the dollar prices of dividend-paying stocks drop to adjust the dividend yield to new higher market yields. When interest rates decline, the prices of these stocks rise to adjust the dividend yield to match lower market interest rates.
- Dividend.com; Introduction to Dividend Stocks
- National Bureau of Economic Research; Why Do Firms Pay Dividends?; Les Picker
- Duke University; Capital Structure and Payout Policies; Campbell R. Harvey; December 1995
- Bloomberg Businessweek; Back to the Future for Dividend and Bond Yields; Chris Farrell; August 2010
- Goodshoot/Goodshoot/Getty Images