How Dividends Work

Dividends are paid to investors by some companies for their ownership in the company. It is really just a form of profit sharing

How Dividends Work

Many Stocks pay Dividends to investors that own the companies stocks. There are no requirements for a company to pay dividends and in fact some investors prefer that no dividends are payed as they argue that the value of a stock can grow more if the company puts its earnings back into the business itself.Personally I am not in that camp. In fact, I only purchase stocks that pay dividends. There are many advantages to dividends that I have presented here. Advantages of Dividend Paying Stocks.

Dividends are paid to investors by some companies for their ownership in the company. It is really just a form of profit sharing. When you purchase stock of a company you are in reality purchasing shares of a company that represents a percentage of ownership. So if a company issues 1 billion shares you in effect own 1 Billionth of that company for each share you purchase. The board of directors decided how much the company will pay based on a percentage of the profits it earns. If the metrics state that the Payout Ratio for the company is 85% that means they are paying its investors 85% of its earning and the company is retaining 15% of its earnings for use by the company as it sees fit.

Usually a company raises its dividends and some companies even raise it on a yearly basis. Again, there is no obligation for them to do so and no set amount or percentage for it to be raised. This is a decision that is made by the company’s board of directors. Companies have no responsibility however, to pay out the dividends to shareholders and occasionally a company that has a history of paying dividends may decide to reduce the dividend per share or even cut the dividend altogether.

There can be various reasons for a company to reduce or cut out its dividend payments such as needing the money for acquisitions of other companies or it could mean that the company is having financial difficulties. One recent example is that of many oil related companies. Many companies reduced or stopped its dividends when the price of oil plummeted for a long period of time. They were producing the same amounts of their product but the collapse in price on the market meant they could not sell it for the prices they were getting. At one point oil was going for over $100 a barrel and then it quickly fell to under $40 per barrel. This affected their cash flow to the point where many were forced to reduce or stop their dividends.

Dividends can be paid in various ways. Most are paid on a quarterly basis but some companies pay monthly, semi annually or even yearly. Some , mostly foreign stocks, can pay on an irregular basis.

Dividends can also take on other forms such as being paid in the form of stock in lieu of cash.

Some companies also choose to pay out special dividends in addition to their regular dividend payments. This is usually done when a company comes into a larger than expected revenue that it has no current plans for the use of the excess cash so they distribute it to shareholders in the form of the special dividend.

If Company XYZ stock (Company XYZ is a fictitious company) currently pays a dividend of $1.60 a share and pays quarterly it will pay share holders every three months ¼th the $1.60 or .40 cents per share. If you happen to own 100 shares of company XYZ then you would receive .40 x 100 = $40.00 in dividends or $160.00 per year.

If company XYZ paid on a monthly basis you would receive 1/12th of the $1.60 each month or .1333 cents per share you owned each month. In this case 100 x .1333 = $ 13.33 each month.

Companies that pay dividends also issue an ex dividend date and a date of record for qualification of receiving the dividend.  An investor must be an owner of record and own the stock by the ex dividend date in order to qualify for the dividend for that period. This mainly affects you during your initial purchase of the stock as after that 1st period you will have owned the stock for the entire qualifying period. This would also apply to dividends issued in company stock. So if company XYZ pays a 5% Stock dividend each year you must also meet the ex dividend and date of record qualifications. So for the stock dividend company XYZ is this example would be your 100 shares x 5% = 5 additional shares you would receive. The Stock Dividend is rare though and very few companies pay dividends with their stock.

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