What are Dividends?

However, not all companies pay dividends. For example, a startup or newly listed company might not have the excess capital on hand to issue payments. Nevertheless, dividend payments are one of the main reasons that investors purchase shares of a company. It’s also important to note that private corporations can also pay dividends to their owners.

How Dividend Payments Work

Before a company can issue a dividend, there are processes and procedures that need to be followed. First, a company will decide to issue a dividend. Once the details are determined, the company will declare the dividend amount, the payment date, and other important details. The date this information is announced is known as the declaration date.

Then, the company will determine which shareholders are eligible to receive the dividend by looking at their records. Generally, a shareholder must own the stock at least two days before the dividend payment date to receive the dividend. The cut-off date for dividend eligibility is known as the ex-dividend date.

Finally, when the payment date arrives, shareholders will receive their payment. Most stock dividends are facilitated through online brokerage accounts. However, if the shares are not held through a brokerage account, the company will mail a dividend check to the address on file.

Types of Dividend Payments

Dividends are most commonly paid in cash; however, companies can use other methods to distribute earnings to shareholders. Let’s go through a few of these dividend payment methods in more detail.

Cash Dividends

Cash dividends are payouts received in cash. This amount is usually allocated per share. For example, if a company distributes $100,000 and they have 50,000 eligible shareholders, each shareholder would receive $2.

Stock Dividends

A stock dividend occurs when a company elects to give shareholders stock instead of cash. These shares can be issued from the company itself or from one of its subsidiaries. This type of dividend is not the same as a stock split. A stock split occurs when a company splits its shares due to an inflated share price. For example, if the company is doing a 2-for-1 stock split, your total number of shares held will double while the share price is cut in half.

Scrip Dividend

A scrip dividend gives the shareholder the ability to choose between a stock or cash dividend.

Liquidating Dividend

A liquidating dividend is a payout for the remaining capital left in the business after all obligations are taken care of. This is a final dividend payment and is usually an attempt to repay investors for their initial contributions. Let’s say you bought shares of a company at $5 each. The company is going bankrupt and shutting down. After paying all debts, the company distributes $2 to each shareholder. Although you won’t recoup the initial stock price you paid, you did receive some return on your investment.

Property Dividend

Property dividends are rare when receiving income from a publicly traded company. These types of dividends are most common in private c corporations with few owners. This type of dividend distributes a tangible asset instead of cash or stock. For example, a shareholder might elect to take a company vehicle as payment instead of cash dividends.

Calculating Dividend Yield

Before investors purchase a company’s stock, they calculate the dividend yield, also known as the dividend rate. This calculation tells you how much you can expect to receive in dividend income as a proportion of your overall investment. Here’s the formula for dividend yield:

Dividend Yield = Annual Dividends Per Share / Market Value Per Share

Let’s say you want to grow your number of dividend stocks. You find a company that pays out $2 per quarter and is currently trading for $75. First, you need to multiply the $2 quarterly payment by four to get the annual dividend amount, which is $8. Then, dividing $8 by the market value of $75 results in a dividend yield of 11%. It’s important to remember that the best dividend isn’t always the one with the highest yield. You need to consider appreciation as well.

When calculating dividend yield, it’s important to understand that the rate can change. For example, a company might fall on hard times and lower their dividend. Another factor that heavily influences dividend yield is the market value. Fluctuations in the trading price will impact your dividend rate. Also, reinvesting your dividends for dividend growth will also sway your dividend yield.

Dividend Income Tax Considerations

Dividend income is generally taxable to the shareholders. Unlike distributions from a partnership, s corporation, or limited liability company, dividends are taxable income. However, dividend income can be taxed at favorable long-term capital gains rates, which range from 0% to 20%, depending on your adjusted gross income.

To understand how your dividends are taxed, you need to determine if the payment is qualifying or non-qualifying. Qualified dividends are eligible for long-term capital gain rate taxation if they meet specific criteria outlined by the IRS. For example, you need to hold the stock for more than 60 days before the ex-dividend date. If you don’t meet this criteria, the dividend income is considered non-qualified and taxed at ordinary income tax rates, which can reach 37%.

These rules are in place to prevent investors from taking advantage of long-term capital gains tax rates by purchasing a dividend stock right before the dividend pays out.

Summary

• Dividends are payments from companies in exchange for holding their stock.
• Dividend payments can take on many different forms, including cash, stock, property, and liquidating.
• The dividend yield is the percentage of the upfront stock price that will be returned in the form of a dividend each year.
• Qualified dividends are taxed at long-term capital gain rates, while non-qualified dividends are taxed at ordinary income rates.