LEVEL: BEGINNER
One of the most compelling reasons to own stocks is the dividend. Simply put, the dividend is a payment that companies pay to shareholders just for holding stock in the company. These dividend payouts can be considered the stockholder’s share of the company’s profits.
Dividends are usually tiny amounts of money, just a few cents, which is why they are often overlooked despite their tremendous power. Most of the successful Wall Street investors depend on dividends for a portion of their investment yield. There is good reason for this; while only a few cents, dividend payouts are fairly regular and reliable sources of income, and many of the largest dividend-yielding companies have been paying out dividends regularly for decades, even generations. Some of the richest families in America, such as the Johnson family of Johnson and Johnson fame (NYSE: JNJ), are not involved in the running of the companies that bear their name, but are still paid millions of dollars every year in dividends.
To understand how dividends work from an investor’s perspective, we first need to consider their structure, and then we can look at how dividend reinvestment, entry points, and appreciating yields can maximize investor return in the long and short term.
Ordinary Dividends
The ordinary dividend is the most common type of dividend, not to be confused with the “special dividend.” The ordinary dividend is a share of a company’s operating profits that is distributed on a regular basis.
Most ordinary dividends are paid out on a quarterly basis, although some companies pay dividends biannually (twice a year), yearly, and monthly. Monthly dividends are particularly common in the so-called “high income funds” that invest in bonds and other fixed-income instruments.
When calculating the dividend yield of a company, investors need to annualize the rate of return and then divided it by the share price. For example, Coca-Cola’s dividend yield as of August 24th was 2.66%: $0.255 paid out quarterly with a share price of 38.40, or (0.255×4)/38.4.
Major Dividend Dates
While ordinary dividends are paid on a set date, there are actually four dates that relate to every dividend payout:
- The Declaration Date – This is the date when the company announces that it will pay out a dividend.
- The Ex-dividend Date – Also called the “reinvestment date,” this is the first day after shareholders are eligible to be paid a dividend. In other words, the ex-dividend date is the first day when shares are no longer eligible for the dividend payment that was declared on the declaration date.
- The Record Date – Usually following the ex-dividend date by a few days, this is the day when companies make a record of who is eligible to receive a dividend payment by seeing if they owned shares on the day before the ex-dividend date.
- The Payable Date – This is the day when dividend payments are actually made.
In most cases, investors really only need to pay attention to the declaration, ex-dividend, and payable dates. Ex-dividend dates are particularly important because they mark the moment when holding a stock no longer qualifies an investor for the dividend and has a major impact on stock prices.
Dividend Payouts and Stock Prices
On a company’s ex-dividend date, the stock of the company will usually go down by the amount of the dividend itself. So, if a company trading at $10 per share offers a dividend of 5 cents, the stock will usually open at $9.95.
Since that loss is immediately impacted by market pressures, dividend-yielding stocks in a bull market will usually recover the amount of the dividend payment pretty quickly, even within a few minutes of trading in some cases. For this reason, some investors strategize buying and selling stocks either immediately before the ex-dividend date to capture the dividend or immediately after to earn the rise in the share price.
Special Dividends
Much like the Christmas bonus of yore, the “special dividend” is a one-time extra payment that companies will pay for a variety of reasons. For the most part, a special dividend is a sign of health: the company is experiencing better-than-expected earnings, so it passes on that profit to the shareholders who, after all, own the company.
Not all special dividends are a good thing. One unusual form of dividend is the “scrip dividend” in which a company offers a dividend payout in the form of additional shares instead of actual cash payments. Such dividends are rare and rarely seen as a good sign by investors, since they’re often a last resort for a firm that doesn’t have the cash to pay out dividends, and cannot or does not want to go into debt to meet investors’ dividend expectations.