A dividend is a share of the profits of a particular company that is distributed to its shareholders, taking into account the number and type of securities they hold in that company.
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A dividend is a part of the company's profit, which is shared among its stockholders proportionally to the number of shares that they own. The amount payable per security is specified in the firm's dividend policy and is approved at the board of directors and shareholders’ meetings.
Dividends may be paid out once a year, once in six months, every quarter, or not at all, depending on the dividend policy of the particular company and its financial situation. Payments can only be guaranteed for preferred shares if the company issues any.
Types of dividends
By the frequency of payment:
- Interim Dividend – paid during the year (for example, quarterly) before the annual general meeting, and can be linked to financial statements. Additional payments may be made, for example, after a successful transaction by the issuer
- Final dividend – paid at the end of the year. As a rule, this is announced at the annual shareholders' meeting. The amount is determined after taking into account the company’s financial results for the last 12 months
By the form of payment:
- Cash dividend – paid in cash
- Stock dividend – paid out in the form of additional shares of the company. Among the advantages is that investors do not pay tax on stock dividends until they sell the shares received
By stock type:
- Preferred dividends are guaranteed and paid out first, given first priority. They are paid out of the company's capital reserves or a special fund, even in the event of a loss-making period
- Ordinary dividends are not guaranteed
How do dividends work?
To be eligible to receive dividends, you need to have purchased shares of the company in question before the dividend payment date, and be on the register of shareholders. There are currently four important dates for shareholders and potential investors to keep in mind:
- Declaration Date or Announcement Date – at their meeting, the company's board of directors and shareholders approve the dividend and its amount and set a record and payment date
- Ex-dividend Date – this is one business day before the Record Date. From this date, buying shares on which dividends are intended to be paid does not entitle the holder to receive dividends
- Record Date – the date set by the company for determining the list of shareholders entitled to receive dividends
- Payment Date – the date on which the dividend is paid out to shareholders
What is the dividend yield?
The dividend yield is the ratio of dividends paid to the value of a security, usually expressed as a percentage. For example, if a share is worth 100 USD and an investor receives 1 USD for a year of holding it, the dividend yield is 1% per year.
What influences dividend payments and their size?
- The launch of the stock buyback programme
- An elevated level of debt burden
- Accumulation of the reserve capital for unforeseen or potential expenses
- No profit, or a rapid decline in profits
- Rapidly increasing losses
- Low level of solvency of the issuer
- Bankruptcy of the company
- A sharp rise in the size of inflation
- An imbalance in the ratio of preferred and ordinary shares
- Increase in taxation
- Legal restrictions on the payment of dividends by the relevant regulatory authorities
- A sudden, rapid, and large-scale deterioration in the economic situation of the country, region, or the world
- Lawsuits and other circumstances causing reputational damage to the company
Risks and limitations of dividends
It is important to remember that a high dividend payout in the past does not guarantee similar payouts in the future. The management and shareholders of the company may decide to change the terms of dividend payments for various reasons, some of which are described above. For example, following the 2008 crisis, about 40% of large companies cut dividends and 14% cancelled them altogether.
If the primary objective of investing in a particular company is to generate dividend income, then it is important to thoroughly study its dividend history, as well as its financial performance over several previous reporting periods. Also, one needs to analyse the economic and geopolitical situation in the country where the issuer is situated, as well as its trading interests. This will allow the potential investor to minimise risks, but it does not guarantee avoiding them altogether.