Understandably, the stock market can be a confusing maze of financial jargon for overwhelmed newcomers, as well as investors looking for a refresher course. To help break down complex financial phrases, here is a glossary of all the terminology related to shares and dividend payments.
Simply put, dividends are the distribution of company earnings to shareholders, as an indication of a bright future and a strong market presence. They are an important means of communicating a company’s financial health and shareholder value to its investors. Dividends can be paid to shareholders in various ways: cash, stock, and property, among others. While most investors prefer to receive cash dividends, stock dividends are also a lucrative option in the long run.
Why Do Companies Issue Dividends? Advantages and Disadvantages of Paying Dividends
Companies pay dividends to their shareholders because it is advantageous, both for themselves and their investors. Large corporations mostly pay dividends on a quarterly basis, but some businesses issue dividends annually, semi-annually, or even monthly. Investing in stocks that pay dividends is beneficial for shareholders, provided it is a high-quality stock. A good dividend stock will provide a steady and fixed stream of income to investors, besides reinstating faith about the company’s financial strength.
The advantages of paying dividends include assuring investors of a reliable earnings source and letting them reap the monetary benefits of the stock’s growth without selling it. More often than not, shareholders prefer the certainty of regular dividend payments, instead of larger capital gains in the future. Distributing profits to shareholders signals a healthy future for the company and gives it additional publicity when it declares dividends.
The primary disadvantage of paying dividends is a decrease in the company’s retained earnings, which could be used to cover unforeseen expenses and debt obligations. Irregular dividend payments may also result in the loss of loyal clientele, who may sell their shares. Hence, it is important for companies to consider these factors before framing a dividend policy, as well as for shareholders before investing in dividend stocks.
Types of Dividends
There are various forms of dividends issued to shareholders such as cash, stock, property, scrip, liquidating, and one-time dividends.
Cash Dividend
The most common form of dividends, a cash dividend is the amount paid to shareholders for each equity share, either as a dollar amount or as a percentage of the current market value. The board of directors of the company decides the amount paid to shareholders and announces the dividend payment on the date of declaration. The dividends are assigned to the company’s shareholders on the date of record, which are then issued on the date of payment.
For example, a company decides to issue a dividend of $5.00 per share and a shareholder owns 1,000 shares of the company’s stock. The shareholder will earn a cash dividend of $5000 (1,000 shares x $5.00).
Generally, cash dividends are paid out of the company’s current earnings or accumulated profits. However, the company must ensure that it has positive retained earnings and sufficient liquidity for the payment of dividends.
Stock Dividend
Typically, companies prefer to issue stock dividends to shareholders when they are low on operating cash. Also known as bonus shares, stock dividends are issued in a manner similar to cash dividends. Each equity shareholder receives additional stock, depending on the number of previously owned shares. Stock dividends are usually expressed as a percentage rather than a dollar amount.
For example, if a company issues a stock dividend of five percent and an investor holds 1,000 shares of its stock, the shareholder will receive an additional 50 shares. Similarly, if a company declares a bonus share issue of 10 shares of stock for every 100 shares owned, a shareholder owning 500 shares would receive 50 shares. It is important to remember that although a stock dividend increases the number of shares owned by a stockholder, it does not necessarily amount to an immediate effect on the overall value of each shareholder’s shares.
Property Dividend
When a company issues a property dividend, the shareholders receive a non-monetary payment in the form of assets such as vehicles, inventory, equipment, etc. The value of the distributed asset will be restated at the fair market value because of the variance from its book value and will be recorded as a loss or gain accordingly.
Scrip Dividend
Due to lack of sufficient funds, a company may choose to issue a scrip dividend, which is essentially a promissory note to pay shareholders at a future date. A scrip dividend may create a note payable and may or may not include interest.
Liquidating Dividend
A liquidating dividend is mainly issued when a company is shutting down its business. The board of directors of the company decides to return the equity shareholders’ original capital contribution as a dividend.
One-Time Dividend
As the name suggests, a one-time dividend is a special dividend that a company may choose to issue in addition to its regular dividend(s. There may be various reasons behind a company’s decision to pay a one-time dividend, such as a sudden cash influx resulting from the sale of a business or considerable compensation from litigation case.
For example, several U.S. companies declared one-time dividends during the last quarter of 2012, in anticipation of higher dividend tax rates that were presumed to go into effect from January 2013.
Dividend Glossary: Dividend Terms Explained
Dividend Record Date: The date on which the company assigns dividends to the shareholders or “holders of record.”
Dividend Declaration Date: The date on which the board of directors of a company announces an upcoming dividend.
Dividend Calendar: The payment schedule for a company’s annual, semi-annual, or quarterly dividend payouts.
Dividend Yield: A financial ratio that measures the amount a company pays out in dividends in comparison with its share price. It is calculated by dividing the annual dividends per share by the current market value of the stock.
Ex-Dividend Date: The date on or after which share trading takes place without considering a previously declared dividend.
Dividend Capture: The term used in the process of buying shares before the ex-dividend date.
Payment Date: The date on which a declared dividend is scheduled to be paid to shareholders.
Dividend Coverage Ratio: The financial ratio between the company’s net income (earnings) to the dividend paid to shareholders. Calculated by dividing earnings per share by the dividend per share, this ratio helps investors determine whether a company has sufficient earnings to issue dividends.
Dividend Payout Ratio: It is the percentage of the company’s earnings paid as dividends to shareholders. The amount of dividend paid to stockholders relative to the total net income of the company. This ratio is used by investors to compare a profitable dividend paying company with a company with high growth potential.
Dividend Reinvestment Plan (DRIP): Certain dividend-paying companies offer shareholders a plan to automatically reinvest cash dividends, by purchasing additional shares of its stock on the dividend payment date.
Qualified Dividend: A type of dividend to for which capital gains tax is applicable. Usually, the tax rates are lower than regular income tax rates.
Dividend ETF: It is an exchange-traded fund which trades like a stock, but that monitors a dividend index, commodities, or assets.
Dividend Discount Model: A method used to value the current market price of a stock by using predicted future dividends and discounting them to present value.
Dividend Investing: An investment strategy that focuses on buying shares of dividend-paying companies.
Dividend-Paying Stocks: They are the corporations whose stocks return a portion of profit and earnings back to shareholders. Dividend-paying stocks provide tangible returns and could belong to various sectors of the market, such as banking, utilities, and consumer goods.
Dividend Rate: It is a dollar amount which expresses the number of times a company pays dividends annually, times the latest dividend.