A company’s earnings that are distributed to shareholders, per the board of directors discretion, are known as dividends. Dividends are usually quarterly, but can be bi-annual, annual, or paid out as special dividends. They are usually paid out as cash dividends, but shareholders can also be remunerated with additional shares.
For example, a company’s board of directors may declare a 10 cent quarterly dividend to its common shareholders. So for each share owned, 10 cents is paid out. If a shareholder owned 100 shares, they would receive a total of $10 ($0.10 x 100 shares = $10).
Depending on a company’s policy, payouts will differ according to the company type. Growth companies such as startup technology firms will often offer a small or no dividend because they typically reinvest earnings for research and development. More stable, defensive companies like utilities usually have a higher payout.
When a company’s board of directors declares a dividend, they will announce a holder of record date, or ex-dividend date. This is the date by which a shareholder must own the stock to be eligible to receive the dividend. In theory, a stock price should decrease by the amount of the payout because these are earnings being distributed to shareholders.
Companies can also elect to pay out dividends with additional stock. A company would choose to do this if cash funds were low or if they were looking to increase the volume of its shares available to the public. A stock dividend is usually expressed in terms as a percentage of shares, so a 0.1 share dividend would translate into half a share for every share owned. In this case, an investor owning 100 shares would receive 10 shares.
Where some investors use dividends as normal income, others may have reinvestment plans that automatically repurchase shares of the company with cash received. These dividend reinvestment plans can be set up by an investor’s broker and can be cancelled at any time.
Investors looking to determine the percentage of earnings distributed to shareholders may use the dividend payout ratio. It is calculated as yearly dividend per share divided by earnings per share. This payout ratio can be affected by a company’s dividend policy, growth rate, and earnings. Investors can also quickly compare one company’s payout to another using the dividend yield formula, calculated as annual dividends per share divided by price per share. This yield ratio measures the dollar value received for each dollar invested.
The tax implications of dividends are a subject of much debate because of how they are classified. Because corporations pay taxes on earnings and investors pay taxes on earnings distributions (in addition to capital gains), this results in a double taxation at the shareholder level. The tax rate applied varies, depending on the stated tax rate applied by the government, the length of time the stock is owned, and the investor’s tax bracket.
During times of depreciating stock values, investors often seek out high dividend paying companies to compensate for the loss of capital gains opportunities. Options traders use arbitrage strategies to capitalize on dividend paying stocks. This would involve buying puts and the underlying stock before the ex date and subsequently exercising the put after being paid the dividend.