Dividends and How They Work

Public corporations have the option of keeping all of their profits each quarter to re-invest in the company, or to distribute some or all of them to their shareholders as a dividend. Growing companies often need as much cash as possible to finance their operations, such as building new manufacturing plants or running marketing campaigns, so they prefer to re-invest their profits. Older, more mature companies that are not growing very much often pay a dividend. Dividends are usually paid out as cash but shareholders are sometimes given the option of receiving extra shares of the company.

How Often Dividends are Paid
Dividends are usually distributed on a fixed schedule, such as every quarter or every month, but special dividends may be distributed at any time. For example, a $4 per share annual dividend paid quarterly would be paid as $1 per share every three months. The Dividend Yield is often mentioned along with the dollar amount. This is simply the annual dividend divided by the current stock price. For example, a $1.00 annual dividend with a share price of $10.00 results in a 10% yield.

Important Dates
People often wonder when they need to own the shares in order to receive the dividend. Typically, you need to own the stock three days before the Record Date for U.S. companies. Here are some important dates:

Declaration Date
This is when the company's board of directors formally announces the dividend, its amount, the date of record, and the payout date.

Ex-dividend Date
This is typically two days before the Record Date and anyone who buys shares on this day or later will not receive this dividend. However, anyone who sells shares this day that were purchased before this day will still receive the dividend. Also noteworthy is that the share price will often drop on this day by an amount approximately equal to the dividend being paid as investors realize the assets of the company will be dropping by this amount.

Record Date
Every shareholder who is properly registered on or before this date will receive the dividend. In most countries, this usually just means you must own the stock before the Ex-dividend Date, which is why the Ex-dividend Date is mentioned more often than the Record Date.

Payment Date
This is when the checks are mailed or the dividends are distributed directly to brokerage accounts.

Taxes on Dividends
In the U.S. dividends are currently taxed at a 15% rate for most individual shareholders. For other qualified individuals it may be much less. Also, if dividends are re-invested, there are certain cases where the dividends will not be taxed right then. However, in most cases there will be some sort of tax involved.

The Power of Dividends and Re-investment
Albert Einstein once said the most powerful force in the universe is the power of compound interest. That concept can be applied to dividends when you choose to have them re-invested. When your dividend is re-invested, it itself will earn money (or shares) on the next payout. In this way, your dividends are compounding, and over time that can really pay off. Many public companies offer Dividend Re-Investment Plans, or DRIPs, so it is wise to check your holdings to see what options are available.

Short-selling and Dividends
If a shareholder has short-sold a stock paying a dividend, it is required that they pay the dividend out of their own pocket to the investor(s) the shares were short-sold to. It is somewhat complicated to explain the reasoning, so please do further research on this topic if interested.

Where to Find Companies with Dividends
Most financial websites list dividend yields for each company but you need to find a website that has a Stock Screener with the ability to search for dividends, such as Yahoo! Finance.

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