A dividend is a payment made by a corporation to its shareholders, usually as a distribution
of profits.
When a corporation earns a profit or surplus, it can either re-invest it in the business,
or it can distribute it to shareholders.
A corporation may retain a portion of its earnings and pay the remainder as a dividend.
Distribution to shareholders can be in cash or, if the corporation has a dividend reinvestment
plan, the amount can be paid by the issue of further shares or share repurchase.
A dividend is allocated as a fixed amount per share, with shareholders receiving a dividend
in proportion to their shareholding.
For the joint stock company, paying dividends is not an expense; rather, it is the division
of after tax profits among shareholders.
Retained earnings are shown in the shareholders' equity section on the company's balance sheet
- the same as its issued share capital.
Public 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 the fixed schedule
dividends.
Cooperatives, on the other hand, allocate dividends according to members' activity,
so their dividends are often considered to be a pre-tax expense.
The word "dividend" comes from the Latin word "dividendum".
Forms of payment Cash dividends are the most common form of
payment and are paid out in currency, usually via electronic funds transfer or a printed
paper check.
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.
For each share owned, a declared amount of money is distributed.
Thus, if a person owns 100 shares and the cash dividend is 50 pence per share, the holder
of the stock will be paid GBP £50.
Dividends paid are not classified as an expense, but rather a deduction of retained earnings.
Dividends paid does not show up on an income statement but does appear on the balance sheet.
Stock or scrip dividends are those paid out in the form of additional stock shares of
the issuing corporation, or another corporation.
They are usually issued in proportion to shares owned.
Nothing tangible will be gained if the stock is split because the total number of shares
increases, lowering the price of each share, without changing the market capitalization,
or total value, of the shares held.
Stock dividend distributions are issues of new shares made to limited partners by a partnership
in the form of additional shares.
Nothing is split, these shares increase the market capitalization and total value of the
company at the same time reducing the original cost basis per share.
Stock dividends are not includable in the gross income of the shareholder for US income
tax purposes.
Because the shares are issued for proceeds equal to the pre-existing market price of
the shares; there is no negative dilution in the amount recoverable.
Property dividends or dividends in specie are those paid out in the 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, such as products and services.
Interim dividends are dividend payments made before a company's Annual General Meeting
and final financial statements.
This declared dividend usually accompanies the company's interim financial statements.
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.
Reliability of dividends Two metrics are commonly used to examine a
firm's dividend policy.
Payout ratio is calculated by dividing the company's dividend by the earnings per share.
A payout ratio greater than 1 means the company is paying out more in dividends for the year
than it earned.
Dividend cover is calculated by dividing the company's cash flow from operations by the
dividend.
This ratio is apparently popular with analysts of income trusts in Canada.
Dividends are payments made by a corporation to its shareholder members.
It is the portion of corporate profits paid out to stockholders.
Dividend dates Any dividend that is declared must be approved
by a company's board of directors before it is paid.
For public companies, there are four important dates to remember regarding dividends.
These are discussed in detail with examples at the Securities and Exchange Commission
site [4] 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.
In-dividend date is the last day, which is one trading day before the ex-dividend date,
where the stock is said to be cum dividend.
In other words, existing holders of the stock and anyone who buys it on this day will receive
the dividend, whereas any holders selling the stock lose their right to the dividend.
After this date the stock becomes ex dividend.
Ex-dividend date is the day on 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.
Existing holders of the stock will receive the dividend even if they now sell the stock,
whereas anyone who now buys the stock 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.
Book closure Date Whenever a company announces a dividend pay-out, it also announces a date
on which the company will ideally temporarily close its books for fresh transfers of stock.
Record date Shareholders registered in the stockholders of record 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 is the day when the dividend cheques will actually be mailed to the shareholders
of a company or credited to brokerage accounts.
Dividend-reinvestment Some companies have dividend reinvestment
plans, or DRIPs, not to be confused with scrips.
DRIPs 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.
Dividend taxation In many countries, such as the U.S.A. and
Canada, income from dividends is taxed, albeit at a lower rate than ordinary income.
Though in most cases, the lower tax rate is due to profits being taxed initially as Corporate
tax.
Australia and New Zealand In Australia and New Zealand, companies also
forward franking credits or imputation 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.
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.
UK The UK's taxation system operates along similar
lines to Australia and New Zealand: 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.
India In India, companies declaring or distributing
dividend, are required to pay a Corporate Dividend Tax in addition to the tax levied
on their income.
Dividend received is exempt in the hands of the shareholder's, in respect of which Corporate
Dividend Tax has been paid by the company.
Effect on stock price After a stock goes ex-dividend, the stock
price should drop.
To calculate the amount of the drop, the traditional method is to view the financial effects of
the dividend from the perspective of the company.
Since the company has paid say £x in dividends per share out of its cash account on the left
hand side of the balance sheet, the equity account on the right side should decrease
an equivalent amount.
This means that a £x dividend should result in a £x drop in the share price.
A more accurate method of calculating this price is to look at the share price and dividend
from the after-tax perspective of a share holder.
The after-tax drop in the share price should be equivalent to the after-tax dividend.
For example, if the tax of capital gains Tcg is 35%, and the tax on dividends Td is 15%,
then a £1 dividend is equivalent to £0.85 of after tax money.
To get the same financial benefit from a capital loss, the after tax capital loss value should
equal £0.85.
The pre-tax capital loss would be £0.85/(1-Tcg) = £0.85/(1-35%) = £0.85/65% = £1.30.
In this case, a dividend of £1 has led to a larger drop in the share price of £1.30,
because the tax rate on capital losses is higher than the dividend tax rate.
Finally, security analysis that does not take dividends into account may mute the decline
in share price, for example in the case of a Price–earnings ratio target that does
not back out cash; or amplify the decline, for example in the case of Trend following.
Criticism Some believe that company profits are best
re-invested back into the company: research and development, capital investment, expansion,
etc.
Proponents of this view suggest that an eagerness to return profits to shareholders may indicate
the management having run out of good ideas for the future of the company.
Some studies, however, have demonstrated that companies that pay dividends have higher earnings
growth, suggesting that dividend payments may be evidence of confidence in earnings
growth and sufficient profitability to fund future expansion.
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.
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.
Capital gains should not be confused with dividends.
Capital gains assume an increase in a stock's value.
Dividend is merely parsing out a share of the profits, and is taxed at the dividend
tax rate.
If there is an increase of value of stock, and a shareholder chooses to sell the stock,
the shareholder will pay a tax on capital gains.
If a holder of the stock chooses to not participate in the buyback, the price of the holder's
shares could rise, but the tax on these gains is delayed until the actual sale of the shares.
Certain types of specialized investment companies allow the shareholder to partially or fully
avoid double taxation of dividends.
Shareholders in companies that 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.
This, in effect, delegates the dividend policy from the board to the individual shareholder.
Payment of a dividend can increase the borrowing requirement, or leverage, of a company.
Other corporate entities Cooperatives
Cooperative businesses may retain their earnings, or distribute part or all of them as dividends
to their members.
They distribute their dividends in proportion to their members' activity, instead of the
value of members' shareholding.
Therefore, co-op dividends are often treated as pre-tax expenses.
In other words, local tax or accounting rules may treat a dividend as a form of customer
rebate or a staff bonus to be deducted from turnover before profit is calculated.
Consumers' cooperatives allocate dividends according to their members' trade with the
co-op.
For example, a credit union will pay a dividend to represent interest on a saver's deposit.
A retail co-op store chain may return a percentage of a member's purchases from the co-op, in
the form of cash, store credit, or equity.
This type of dividend is sometimes known as a patronage dividend or patronage refund,
as well as being informally named divi or divvy.
Producer cooperatives, such as worker cooperatives, allocate dividends according to their members'
contribution, such as the hours they worked or their salary.
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
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 from dividends representing
distribution of earnings.
Mutuals The distribution of profits by other forms
of mutual organization also varies from that of joint stock companies, though may not take
the form of a dividend.
In the case of mutual insurance, for example, in the United States, a distribution of profits
to holders of participating life policies is called a dividend.
These profits are generated by the investment returns of the insurer's general account,
in which premiums are invested and from which claims are paid.
The participating dividend may be used to decrease premiums, or to increase the cash
value of the policy.
Some life policies pay nonparticipating dividends.
As a contrasting example, in the United Kingdom, the surrender value of a with-profits policy
is increased by a bonus, which also serves the purpose of distributing profits.
Life insurance dividends and bonuses, while typical of mutual insurance, are also paid
by some joint stock insurers.
Insurance dividend payments are not restricted to life policies.
For example, general insurer State Farm Mutual Automobile Insurance Company can distribute
dividends to its vehicle insurance policyholders.
See also
References
External links Ex-Dividend Dates: When Are You Entitled to
Stock and Cash Dividends – U.S. Securities and Exchange Commission
Why Should Companies Pay Dividends?
Dividend Policy from studyfinance.com at the University of Arizona
Common Stock Dividends Ex-Dividend Dates for Common Stock Dividends
The new U.S. dividend tax cut traps from Tennessee CPA Journal, Nov. 2004
UK Dividend Tax Rates