Dividend (finance)
In finance, a dividend is a portion of a company's profits distributed to its shareholders, often in regular installments. Dividends can be a key source of income for investors, and their performance is measured by the dividend yield, which represents the dividend return relative to the share price over a year. Typically, dividends are paid quarterly, but they can also be issued semiannually or annually. There are several forms of dividends, including cash dividends, stock dividends, and extraordinary dividends, with cash dividends being the most common.
Investors can choose to receive dividend payments as cash or reinvest them to acquire more shares. Companies determine their dividend payout policies through various models, such as stable payouts or target payout ratios, which influence how much investors receive. While dividends can provide a reliable income stream and be indicative of a company's stability, they also carry risks. Changes in a company’s financial performance can lead to alterations in dividend policies, affecting the payouts investors receive. Thus, understanding dividends is crucial for investors looking to generate returns and evaluate stock stability.
Dividend (finance)
In finance, a dividend is a share of a company's profits, distributed in regular installments to shareholders in the enterprise. The amount of profit the company shares with investors is known as the dividend yield, which is expressed as a percentage that indicates the dividend return on the initial share price received by the investor over a one-year period. Dividends are usually paid quarterly (four times a year), though some companies pay them semiannually (twice a year) or annually (once a year).
Types of Dividends
Not all companies offer dividends to investors, but those that do typically issue them in one of three forms. The first and most common of these forms is the cash dividend, which is a dividend paid directly to an investor in cash money. Another is the stock dividend, a type of payout in which the company offers the investor an additional stake in the company in the form of full or partial shares. The third and least common type of dividend is known as an extraordinary dividend, which occurs when a company's board of directors decides to issue bonus payments to its investors, usually as part of a strategy to reduce the company's tax liability for a given period.
Most investors hold their shares in special accounts known as brokerage accounts. Companies that pay cash dividends typically offer the investor the option to receive the money as cash deposited directly into the brokerage account, or to reinvest the dividend payment by purchasing additional shares in the company at market value. Investors seeking to generate income from their investments usually opt for cash payments, while those seeking long-term capital growth are more likely to opt into dividend reinvestment plans.
Calculating the Dividend Yield
The dividend yield is calculated by totaling the amount of money paid out in dividends on a per-share basis over the past year, dividing that sum by the market price of the stock when it was purchased, then multiplying by 100 to generate a percentage. For example, assume that ABC Corporation pays dividends quarterly, and that its last four dividend payments were $0.10, $0.12, $0.12, and $0.14 per share. Therefore, ABC Corporation has paid out a total of $0.48 per share in dividends over a one-year period. If the market value of ABC Corporation was $10.00 per share when the investor purchased it, the dividend yield would be $0.48 divided by $10.00, then multiplied by 100 to reach 4.8 percent.
Dividend Payout Policies
As dividends are entirely elective, the models used to determine dividend payouts vary, depending on the specific policies of the company offering them. Companies use one of four models to determine the amount of money or equivalent assets investors will receive through dividends. These models include stable payouts, target payout ratios, constant payout ratios, and residual dividends.
Stable payouts are dividend payments that are not tied to the company's earnings or profits; rather, they are set at a fixed amount, where they remain until the company's board of directors elects to change them.
Target payout ratios represent a variation on stable dividend models. These dividends are set at a specified percentage of a company's earnings, with the per-share payout being expressed at a theoretically fixed dollar amount that can be adjusted upward or downward, depending on how close the company comes to reaching its stated earnings targets.
The constant payout ratio model offers dividends as a percentage of the company's annual earnings; payouts are not adjusted upward or downward depending on how close the company comes to hitting its earnings targets. Instead, investors receive greater dividends when the company's earnings rise and lesser dividends when the company's earnings fall.
The residual dividend model is similar to the constant payout ratio model, except that the company retains a specified amount of the funds it generated to meet its capital budget requirements. Leftover funds, known as residual profits, are then distributed to shareholders as dividends.
Advantages and Disadvantages of Dividend Stocks
Dividends have long been attractive to investors seeking securities with an inherent ability to generate returns. According to some expert estimates, 40 percent of the total returns generated by the American stock market since 1930 have come from dividends. Dividends allow investors to get paid for owning stock in a particular company, and companies that want to attract investors will often offer dividends as a strategy for increasing the built-in value proposition for its shareholders.
Another advantage of dividend stocks is that the income they generate through quarterly, semiannual, or annual payments is taxed at a lower rate than many other forms of income. Therefore, investors can shield significant portions of their profits from taxation by leaving them in income-generating dividend stocks, a strategy that has been successfully deployed by a large number of investors for many years.
Finally, investors can use the presence or absence of dividend payments as a means of evaluating the relative safety or risk of a given stock before purchasing it. Generally speaking, companies that pay dividends are viewed as more stable, since the presence of dividends typically implies that the company has been consistently profitable for an extended period of time. Conversely, companies that do not pay dividends can be seen as riskier propositions since they may not have the same history of profitability.
However, as with all securities, the value of a dividend-yielding stock can go down, creating a net loss for the investor despite the fact that the investor is receiving regular payouts. Similarly, a company can change its dividend policy at any time, for example, by reducing the amount to be redistributed to investors, changing from a fixed dividend model to a variable dividend model, or eliminating dividend payments altogether. Dividend policy is generally altered against the investor's favor when a company's financial performance declines for an extended period. As with all investments, dividend-bearing stocks come with risks that must be carefully evaluated before the investor makes a financial commitment.
Bibliography
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Hamm, Trent. "Personal Finance 101: What Is a Dividend?" The Simple Dollar. TheSimpleDollar.com. 4 Sept. 2014. Web. 28 Jan. 2016. http://www.thesimpledollar.com/personal-finance-101-what-is-a-dividend/
Short, Doug. "The History of Dividends: Why They Went Away, and Why They May Come Roaring Back." Business Insider. Business Insider Inc. 14 Oct. 2010. Web. 28 Jan. 2016. http://www.businessinsider.com/the-history-of-dividends-2010-10?IR=T
Tillier, Martin. "What Is a Dividend?" NASDAQ. The NASDAQ, Inc. 20 Aug. 2013. Web. 28 Jan. 2016. http://www.nasdaq.com/article/what-is-a-dividend-cm269103