Financial Lit: Dividends

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An important issue when investing in stocks is the dividend rate. You'll want to know if the stock you're considering pays a dividend and if so, how much. You'll also want to know if the dividend is going to continue and possibly increase in the future.

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It's key to understand how dividends work and what to look for.

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What Are Dividends?

A dividend is a portion of a company's profits that it pays to its shareholders. The percentage of earnings a corporation pays out in dividends varies by company. Some companies keep more of their profits to finance growth, while others pay out higher dividends to make their stock attractive to buyers.

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Companies usually pay dividends on a fixed calendar schedule, but they can sometimes declare unscheduled dividends known as special or extra dividends. Dividends are typically stated as a set amount per share.

Consider also​: Dividend Payment Factors

Not all companies pay dividends.

How Do They Work?

There are certain dates that apply to the payment of dividends.

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  • Declaration date:​ This is the date when a company announces it will pay a dividend.
  • Record date:​ This is the date by which investors must be registered as shareholders on the company's books to receive a dividend.
  • Ex-dividend date:​ The ex-dividend date, which is set one day before the record date, means shareholders must own their shares at least one full business day before the record date. You must purchase the stock before the ex-dividend date to meet the ownership requirement.
  • Payable date​: This is the date when shareholders actually receive their dividends.

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As an example, suppose on Tuesday, September 28th, a company declared its intention to pay a dividend to shareholders on the record date of Thursday, October 7th. This means the ex-dividend date would be Tuesday, October 5th. Therefore, shareholders must have purchased their shares on or before Monday, October 4th to receive a dividend.

The payable date is normally a few days later at the discretion of the company.

Do All Stocks Pay Dividends?

No. Not all companies pay dividends. Some prefer to keep the profits in their business and use the money to fund expansion or pay down its debt. When a company expands and profits increase, shareholders benefit by an increase in the stock's price.

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High-tech companies, like Dell Technologies, Biogen and Electronic Arts, are known for not paying dividends, but instead rely on rapid growth to increase their share price. Other companies, such as AT&T, Coca-Cola and Chevron, have a policy of paying higher dividends to make their stock attractive.

However, if a company has a history of paying dividends and has to skip a payment, this could be a negative sign that the company is experiencing cash-flow issues, which would have a negative effect on its share price.

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Can Dividends Be Reinvested?

Yes. Some companies give their shareholders the alternative to purchase additional shares in the company rather than accepting the payments in cash. These are known as dividend reinvestment plans (DRIPs).

What Is a Stock Dividend?

In order to preserve cash, cash companies will issue additional shares of stock rather than paying a dividend. Companies take this approach sometimes to preserve cash but still create an incentive for investors to purchase their stock.

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Consider also:Ordinary Dividends Vs. Qualified Dividends

What Are the Tax Implications?

The tax rate on dividends depends on whether the dividends are considered as ordinary or qualified as stated on IRS Form 1099-DIV. Ordinary dividends are taxed at an individual's normal personal income rate, while qualified dividends are taxed at a lower capital gains tax rate.

To receive the more favorable capital gains tax rate, the recipient of the dividends must own the stock at least 60 days before and after the ex-dividend date. If the dividends are for preferred stock, you must own the shares at least 90 days before and after the ex-dividend date.

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The U.S. Securities and Exchange Commission (SEC) has further explanations on how dividends should be taxed, and you should consult your tax advisor for your particular situation.

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