The concept of dividends is basic investing know-how, but often remains unexplained. When you purchase shares in a company, you naturally hope the price of the shares will increase. However, you also look for a return on your investment in the form of a dividend payout. As a shareholder of company X, you own part of the company. One of your basic rights as a shareholder is to be paid a share of the company’s profits.
Sometimes a company will choose to use its excess cash, or profits, to buy back shares from its investors; thus, reducing the number of shares outstanding in the market. The company may feel its shares are undervalued in the marketplace and, therefore, decides to provide investors with a fair return, while at the same time boosting the valuation of its stock. This happens because the company’s earnings are allocated over a smaller number of shares. Thus, the current earnings per share (EPS) increases. If the same price-to-earnings (P/E) ratio is maintained, the price of a share will increase.
A company can share a portion of its profits with four different types of dividends. Your monthly brokerage statement might show a CASH dividend, a STOCK dividend, a HYBRID dividend or a PROPERTY dividend.
Cash Dividends Are by Far the Most Common
When you visit Dividend.com, you can insert a stock ticker symbol into the search box at the top of the page. We’ll use Coca-Cola (KO) as an example. Click on the Dividend History link on the left side of the page. There you’ll find the latest quarterly dividend payout ($0.35) per share, along with the declared, ex-dividend, record and payable dates. Now click on the Dashboard link on the left side of the page. You’ll see a table showing the annualized dividend payout ($1.40) and the dividend yield (annual dividend ($1.40)/current stock price ($42) = 3.33%.
The complete dividend and stock split history of a stock is easily accessible to investors. In the case of KO, you can find a complete history here. Let’s say you’re interested in 10 stocks and you want to find out the next dividend payout dates for each and what the ex-dividend dates are. Remember, an investor must own a stock as of the declared record date in order to receive the dividend. If you purchase a stock on or after the ex-dividend date, you will not receive the dividend. Use the Ex-Dividend Date Search tool to search all securities, based on the specific date ranges you choose. And with a premium subscription, you can download the data into a spreadsheet for easy reference.
Stock Dividends (Dividends in Kind) are a different kind of animal altogether. Let’s say a company declares a 10% stock dividend. An investor owning 100 shares would receive an additional 10 shares, for a total of 110 shares. However, the total market value of the company hasn’t changed! If the investor-owned 1% of the company prior to the stock dividend, he continues to own 1% of the company after the stock dividend. The only change is in the price of his shares. He owns 10% more shares, but each share is priced 10% lower. In effect, a stock dividend is like a mini stock split. It doesn’t add any real value to the shareholder. Over the past two decades, the frequency of stock dividend payouts has dropped substantially.
Why Would A Company Choose to Distribute Stock Dividends?
One reason might be to direct its earnings toward developing the firm through internal growth. Another reason might be to minimize the distribution of cash to shareholders in anticipation of an outside acquisition. The company could then use its retained cash and new debt to fund the acquisition. Still another reason might be to spin-off a subsidiary company. In 1988, Coca Cola did just that. It spun-off its subsidiary, Columbia Pictures Entertainment Inc., to its shareholders. For each share of KO an investor owned, he received 0.092 share of Columbia Pictures at a cost basis of $7.4375 per share.
In the previous example, an investor received a fractional share of Columbia Pictures stock from the spin-off for each share of KO that he owned. Fractional shares can occur because of a stock split, a dividend reinvestment plan (DRIP), a merger, an acquisition or a spin-off. An investor can’t buy fractional shares on the market and, conversely, they can be difficult to sell. The only way to sell fractional shares is through a major brokerage firm, which would pair each partial share sale order with other partial share sale orders.
Hybrid Dividends are a mixture of cash payout with stock payout. Here’s an example. An investor owns 100 shares of XYZ Corporation. The company declares a stock-and-cash dividend of 30 cents per share, plus 10% of the shares owned. The investor would receive a $30 cash dividend and 10 additional shares of XYZ stock. The investor may well feel as if he’s getting a better deal by receiving both types of dividends.
Property Dividends are non-monetary dividends, but they do have monetary value. An example might be as follows. ABC Corporation has 1,000 shareholders. The company owns 1,000 signed Warhol prints, which it has stored in its vault for many years. The fair market value of the prints is $1,000,000. The company decides to distribute one print to each of its shareholders. Each print is worth $1,000. The shareholder may decide to sell the print, or he may wish to hold onto the print for additional, long-term capital gains.
Which Type of Dividend Is Preferable?
That depends on the individual investor’s perspective. If he is interested in capital gains, he would likely prefer to receive stock dividends, which are not taxed until he sells the shares. If he is interested in a regular source of income, he would prefer the immediate cash liquidity of a cash dividend. Cash dividends give the investor more flexibility. He could buy additional shares of the company, if he so chooses. On the other hand, he may simply use the cash to cover his monthly bills. In any case, cash dividends are considered taxable income in the year they are received by the investor.
Stock dividends aren’t really something one should be worried about because their frequency has dropped in the last 15-20 years. This is an educated observation, since precise numbers across the stock universe are difficult to find.
There’s a wealth of data and informative articles at Dividend.com. This brief article only skims the surface. Find out more about why stock dividends really aren’t dividends in Myths and Facts About Dividend Investing. Or find out more about dividend reinvestment plans also employ the fractional shares concept).
Be sure to delve into our Financial Education Center. It’s aptly named Dividend University! There, you’ll learn everything you want to know about dividends from A to Z.
