Dividends

Dividends 

Dividends are payments made by a company to its shareholders. When a company earns a profit, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be paid to the shareholders of the company as a dividend. Paying dividends is not an expense; rather, it is the division of an asset among shareholders. Many companies retain a portion of their earnings and pay the remainder as a dividend. Publicly-traded companies usually pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special dividend to distinguish it from a regular one.

Dividends are usually settled on a cash basis, as a payment from the company to the shareholder. They can also take the form of shares in the company (either newly-created shares or existing shares bought in the market), and many companies offer dividend reinvestment plans, which automatically use the cash dividend to purchase additional shares for the shareholder.

Overview

The profits of a company can either be reinvested in the business or paid to its shareholders as a dividend. The frequency of these varies by country. In the United States, dividends of publicly-traded companies are usually declared quarterly by the board of directors. In some other countries dividends are paid biannually, as an interim dividend shortly after the company announces its interim results and a final dividend typically following its annual general meeting. In other countries, the board of directors will propose the payment of a dividend to shareholders at the annual meeting who will then vote on the proposal.

In the United States, a decision regarding the amount and frequency of dividends is solely at the discretion of the board of directors (see Investing 101 [1]. Shareholders are explicitly forbidden from introducing shareholder resolutions involving specific amounts of dividends (SEC Form 8-A [2])

Where a company makes a loss during a year, it may opt to continue paying dividends from the retained earnings from previous years or to discontinue the dividend. Where a company receives a non-recurring gain, e.g. from the sale of some assets, and has no plans to reinvest the proceeds, the money is often returned to shareholders in the form of a special dividend. This type of dividend is often larger than usual and occurs outside of the normal dividend distribution schedule.

Forms of payment

Cash

Cash dividends (most common) are those paid out in form of cheques. Such dividends are a form of investment income and are usually taxable to the recipient in the year they are paid. This is the most common method of sharing corporate profits with the shareholders of the company.

ex: For each share owned, a certain amount of money is distributed to each shareholder. Thus, if an investor owns 100 shares and the cash dividend is $0.50 per share, the owner will receive $50 in total.

Stock

Stock or scrip dividends are those paid out in form of additional stock shares of the issuing corporation, or other corporation (e.g., its subsidiary corporation). They are usually issued in proportion to shares owned (e.g., for every 100 shares of stock owned, 5% stock dividend will yield 5 extra shares). This is very similar to a stock split in that it increases the total number of shares while lowering the price of each share and does not change the market capitalization or the total value of the shares held.

Property

Property dividends or dividends in specie (Latin for "in kind") are those paid out in form of assets from the issuing corporation or another corporation, such as a subsidiary corporation. They are relatively rare and most frequently are securities of other companies owned by the issuer, however they can take other forms, e.g. products or services.

Other

Dividends can be used in structured finance. Financial assets with a known market value can be distributed as dividends; warrants are sometimes distributed in this way.

For large companies with subsidiaries, dividends can take the form of shares in a subsidiary company. A common technique for "spinning off" a company from its parent is to distribute shares in the new company to the old company's shareholders. The new shares can then be traded independently.

Dates

Dividends must be "declared" (approved) by a company’s Board of Directors each time they are paid. There are four important dates to remember regarding dividends. These are discussed in detail with examples at the Securities and Exchange Commission site [3]

Declaration date

The declaration date is the day the Board of Directors announces its intention to pay a dividend. On this day, a liability is created and the company records that liability on its books; it now owes the money to the stockholders. On the declaration date, the Board will also announce a date of record and a payment date.

Ex-dividend date

Main article: Ex-dividend date

The ex-dividend date is the day after which all shares bought and sold no longer come attached with the right to be paid the most recently declared dividend. This is an important date for any company that has many stockholders, including those that trade on exchanges, as it makes reconciliation of who is to be paid the dividend easier. Prior to this date, the stock is said to be cum dividend ('with dividend'): existing holders of the stock and anyone who buys it will receive the dividend, whereas any holders selling the stock lose their right to the dividend. On and after this date the stock becomes ex dividend: existing holders of the stock will receive the dividend even if they now sell the stock, whereas anyone who now buys the stock now will not receive the dividend.

It is relatively common for a stock's price to decrease on the ex-dividend date by an amount roughly equal to the dividend paid. This reflects the decrease in the company's assets resulting from the declaration of the dividend. The company does not take any explicit action to adjust its stock price; in an efficient market, buyers and sellers will automatically price this in.

Record date

Shareholders who properly registered their ownership on or before the date of record will receive the dividend. Shareholders who are not registered as of this date will not receive the dividend. Registration in most countries is essentially automatic for shares purchased before the ex-dividend date.

Payment date

The payment date is the day when the dividend checks will actually be mailed to the shareholders of a company or credited to brokerage accounts.

Dividend-reinvestment plans

Some companies have dividend reinvestment plans, or DRIPs. These plans allow shareholders to use dividends to systematically buy small amounts of stock, usually with no commission and sometimes at a slight discount. In some cases the shareholder might not need to pay taxes on these re-invested dividends, but in most cases they do.

Benefit to shareholders

• Shareholders have their own personal cash needs and self-select the companies whose dividends satisfy these.

• Preferred shareholders like common share dividends because it creates a cushion that must be cut before their own dividends are.

• Shareholders feel that the risk of returns from reinvested earnings at a later date is higher than the risk of cash received today.

• Benjamin Graham and David Dodd, in the 1934 book Security Analysis, suggest that retaining earnings is, in effect, management dictating to owners how to invest their money. However, Graham's protege Warren Buffett prefers retained earnings to dividends because of the less punitive tax regime that they are subject to.

Cons

• Management and the board may believe that the money is best re-invested into the company: research and development, capital investment, expansion, etc. Proponents suggest that a management eager to return profits to shareholders may have run out of good ideas for the future of the company. Some studies have demonstrated that companies that pay dividends have higher earnings growth, however, suggesting that dividend payments may be evidence of confidence in earnings growth and sufficient profitability to fund future expansion.^[1]

• When dividends are paid, individual shareholders in many countries suffer from double taxation of those dividends: the company pays income tax to the government when it earns any income, and then when the dividend is paid, the individual shareholder pays income tax on the dividend payment; in many countries, the tax rate on dividend income is lower than for other forms of income to compensate for tax paid at the corporate level. Taxation of dividends is often used as justification for retaining earnings, or for performing a stock buyback, in which the company buys back stock, thereby increasing the value of the stock left outstanding. In contrast, corporate shareholders often do not pay tax on dividends because the tax regime is designed to tax corporate income (as opposed to individual income) only once. The shareholder will pay a tax on capital gains (which is often taxed at a lower rate than ordinary income) only when the shareholder chooses to sell the stock. If a holder of the stock chooses to not participate in the buyback, the price of the holder's shares should rise, but the tax on these gains is delayed until the actual sale of the shares. Certain types of specialized investment companies (such as a REIT in the U.S.) allow the shareholder to partially or fully avoid double taxation of dividends.

• Shareholders in companies which pay little or no cash dividends can reap the benefit of the company's profits when they sell their shareholding, or when a company is wound down and all assets liquidated and distributed amongst shareholders.

Miscellaneous specific types

  Franking credits

In Australia and New Zealand, companies also forward franking credits to shareholders along with dividends. These franking credits represent the tax paid by the company upon its pre-tax profits. One dollar of company tax paid generates one franking credit. Companies can forward any proportion of franking up to a maximum amount that is calculated from the prevailing company tax rate: for each dollar of dividend paid, the maximum level of franking is the company tax rate divided by (1 - company tax rate). At the current 30% rate, this works out at 0.30 of a credit per 70 cents of dividend, or 42.857 cents per dollar of dividend. The shareholders who are able to use them offset these credits against their income tax bills at a rate of a dollar per credit, thereby effectively eliminating the double taxation of company profits. This system is called dividend imputation.

The UK's taxation system operates along similar lines: when a shareholder receives a dividend, the basic rate of income tax is deemed to already have been paid on that dividend. This ensures that double taxation does not take place, however this creates difficulties for some non-taxpaying entities such as certain trusts, charities and pension funds which are not allowed to reclaim the deemed tax payment and thus are in effect taxed on their income.

 Dividends from trusts

In real estate investment trusts and royalty trusts, the distributions paid often will be consistently greater than the company earnings. This can be sustainable because the accounting earnings do not recognize any increasing value of real estate holdings and resource reserves. If there is no economic increase in the value of the company's assets then the excess distribution (or dividend) will be a return of capital and the book value of the company will have shrunk by an equal amount. This may result in capital gains which may be taxed differently than dividends representing distribution of earnings.

Reliability of dividends

There are two metrics which are commonly used to evaluate whether a company can sustain its current dividend payout in the long term.

Dividend cover is calculated by dividing the company's earnings per share by the dividend. A dividend cover of less than 1 means the company is paying out more in dividends for the year than it earned.

Payout ratio is calculated by dividing the company's cash flow from operations by the dividend. This ratio is used by analysts of income trusts in Canada.

Etymology and related uses

The word "dividend" comes from the Latin word "dividendum" meaning "the thing which is to be divided".^[2]

In the United States, credit unions generally use the term "dividends" to refer to interest payments they make to depositors. These are not dividends in the normal sense and are not taxed as such; they are just interest payments. Credit unions call them dividends since, as credit unions are owned by their members, interest payments are effectively payments to owners.

Consumer co-operative societies use the term "dividend" for profit-sharing payments to their members. Unlike joint stock company dividends, these payments are made in proportion to a members' spending with the co-operative society, not the number of shares they hold in it.