Dividend
From Exampleproblems
A dividend is the distribution or sharing of parts of profits to a company's shareholders.
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Why companies pay dividends
The primary purpose of any business is to create profit for its owners, and the dividend is the most important way the business fulfills this mission. When a company earns a profit, some of this money is typically reinvested in the business and called retained earnings, and some of it can be paid to its shareholders as a dividend. Paying dividends reduces the amount of cash available to the business, but the distribution of profit to the owners is, after all, the purpose of the business.
How dividend is determined
The amount of the dividend is determined every year at the company's annual general meeting, and declared as either a cash amount or a percentage of the company's profit.
The dividend is determined mainly on the basis of the company's unappropriated profit and its business prospects for the coming year (see The dividend decision). It is then proposed by the Executive Board and the Supervisory Board to the annual general meeting.
The dividend is the same for all shares of a given class (that is, preferred shares or common stock shares). Once declared, a dividend becomes a liability of the firm.
For most companies, the amount of the dividend remains constant. This is to reassure investors, especially during phases when earnings are low, and sends the message that the company is optimistic with respect to its future performance.
Cum-dividend
Cum Dividend means "with dividend". A stock trades cum-dividend up until the ex-dividend date. Before this date, a stock buyer is still entitled the dividend rights (ie to receive a dividend that has been declared, but not paid). However, on or after this date, the stock buyer is no longer entitled to the dividend rights.
Ex-dividend
Ex-dividend means "exclude dividends. When a share is sold shortly before the dividend is to be paid, the seller rather than the buyer is entitled to the dividend. At the point at which the buyer is not entitled to the dividend if the share is sold, the share is said to go ex-dividend. This is usually two business days before the dividend is to be paid, depending on the rules of the stock exchange. When a share goes ex-dividend, its price will generally fall by the amount of the dividend.
Type of dividends
The methods of sharing profits are as follows:
- Cash dividends (most common) are those paid out in form of "real cash". It is a form of investment interest/income and are taxable in the year they are paid. It is the most common method of sharing corporate profits.
- Stock dividends (common) are those paid out in form of additional stock shares of the issuing corporation, or other coporation (eg its subsidiary corporation). They are usually issued in proportion to shares owned (eg for every 100 shares of stock owned, 5% stock dividend will yield 5 extra shares).
- When the company distributes these new shares to investors, the price of each share decreases to account for the new shares. This is a recalculation of cost basis. It means that the stock dividends will not be taxed when distributed.
- Stock dividends benefit the corporation in that they don't need to pay out in "real cash", reducing the financial burdens and saving moeny for other business operations (eg business expansion).
- Stock dividends also benefit the shareholder by increasing his/her number of shares of the company.
- Property dividends (rare) are those paid out in form of assets from the issuing corporation, or other coporation (eg its subsidiary corporation). Property dividends are usually paid in the form of products or services provided by the corporation. When paying property dividends, the corporation will often use securities of other companies owned by the issuer.
Dividend-reinvestment plans
Some companies have dividend-reinvestment plans. These plans allow shareholders to use dividends to systematically buy small amounts of stock often at no commission. Dividends are not yet paid in gold certificates although this idea has been discussed by mining companies such as Goldcorp.
Reasons why companies avoid paying cash dividends
Companies have often avoid paying cash dividends for several reasons:
- Company management and the board believe that it is important for the company to take advantage of opportunities before it, and reinvest its recent profits in order to grow, which will ultimately benefit investors more than a dividend payout at present. This reasoning is sometimes right, but is often wrong, and opponents of this reasoning (such as Benjamin Graham and David Dodd, who complained about the practice in the classic 1934 reference Security Analysis) usually note that this comprises company management dictating to the business's owners how to invest their own money (i.e. the profit of the business).
- When dividends are paid, shareholders in many countries, including the United States, suffer from double taxation of those dividends: the company pays income tax to the government when it earns any income, and then when the dividend is paid, the individual shareholder pays income tax to the government on the dividend payment. This is often used as justification for retaining earnings, or for performing a stock buyback, in which the company buys back stock, thereby increasing the value of the stock left outstanding. The shareholder pays no income tax on this transaction. In addition, certain types of specialized investment companies (such as a REIT in the U.S.) allow the shareholder to partially or fully avoid double taxation of dividends.
Microsoft is an example of a company who has historically been a proponent of retaining earnings; it did so from its IPO in 1986 until 2003, when it declared it would start paying dividends. By this point Microsoft had accumulated over US$43 billion in cash, and there had been increasing irritation from stockholders who believed this large pile of cash should lie in their hands and not in the company's. Originally, the official reason to amass this large sum was to create a reserve for Microsoft's legal battles; since then, Microsoft appears to have changed tactics such that the reserve is not as necessary.
Franking Credits
In Australia and New Zealand, companies also forward franking credits to shareholders along with dividends. These franking credits represent the tax paid by the company upon its pre-tax profits. One dollar of company tax paid generates one franking credit. Companies can forward any proportion of franking up to a maximum amount that is calculated from the prevailing company tax rate: for each dollar of dividend paid, the maximum level of franking is the company tax rate divided by (1 - company tax rate). At the current 30% rate, this works out at 0.30 of a credit per 70 cents of dividend, or 42.857 cents per dollar of dividend. The shareholders who are able to use them offset these credits against their income tax bills at a rate of a dollar per credit, thereby effectively eliminating the double taxation of company profits. This system is called dividend imputation.
About the name "Dividend"
The name comes from the arithmetic operation of division: if a / b = c then a is the dividend, b the divisor, and c the quotient.
In the United States, credit unions generally use the term "dividends" to refer to interest payments they make to depositors. These are not dividends in the normal sense and are not taxed as such; they are just interest payments. Credit unions call them dividends since, as credit unions are owned by their members, interest payments are effectively payments to owners.
In the United Kingdom, consumer co-operative societies use the term "dividend" for profit-sharing payments to their members. Unlike joint stock company dividends, these payments are made in proportion to a members' spending with the co-operative society, not the number of shares they hold in it.
See also
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External links
- Dividend Policy from studyfinance.com at the University of Arizona
- Stock Dividends
- dividend discount formulade:Dividende
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