Dividend is a share of a company's profit typically paid to its shareholders on quarterly basis or once in a year. It is a pleasant matter associated with holding stocks. As a shareholder, you own a part of the company, even if it's a negligible stake. You bear the risk of business operations, for which you have the right to be rewarded in the form of a share in the profit.
Who Decides on Dividend Payment
Shareholders themselves decide on the payment of dividends (= owners) at the general meeting. The management, whose members may not necessarily be shareholders, only proposes a certain dividend amount, and the final approval rests with the general meeting.
Dividends are paid from net income, i.e., profit after taxation. Whether the dividend will be paid or not depends on several factors. First and foremost, the company must have some profit, either from the current or past periods, and then it depends on the company's strategy or the stage of its life cycle.
Young companies usually do not pay dividends and reinvest the income back into the company for business activity expansion. Established, usually large, companies in the maturity phase, which either don't have much room for growth or they lack investment opportunities, pay shareholders a certain portion of the profit in the form of dividends. This strategy is called dividend policy, and the portion of profit going to dividends is the payout ratio.
There are companies that pay 100% of the profit to shareholders, i.e., the entire profit earned (for example, tobacco manufacturer Phillip Morris in the Czech Republic). Some companies announce in advance that they will pay a certain share of the profit, for example, 50 to 70%, in dividends, retaining maneuvering space between investments in the company's activities and dividend payments to shareholders. The goal of reinvesting profit is to achieve even greater future profit and, thus, higher dividends.
Example of Profit Distribution, Taxation, and Dividend Payment
The company achieves a net income of $10 million. There are 1 million shares outstanding or in circulation. The net income per share is $10. The payout ratio in line with the company's dividend policy is 50%. Therefore, the company decides to pay a dividend of $5 per share.
Various financial websites, e.g. Yahoo Finance, often publish the dividend yield in relation to the current market price of a stock. This yield is a percentage that reflects the annual dividend income as a proportion of the current stock price. It provides a quick way for investors to assess the income potential of a stock based on the latest market conditions.
It's worth noting that as an investor, you may also calculate your personal yield based on the average price at which you initially bought the stocks. Your individual yield can differ from the published yield, offering you a more personalized insight into the performance of your investment relative to your own cost basis.
The payment to each shareholder depends on how many shares they own. Dividends are usually subject to a withholding tax, e.g. 15%. The company deducts the tax, which is called the withholding tax, and the shareholder receives only net dividends.
How to Get a Dividend, Who Is Entitled to It
You are entitled to a dividend if you own shares of a company on the so-called record date. Laypeople are often surprised that ownership of shares is sufficient for a dividend claim on this one single day of the year. You don't need to hold the shares for the entire period; it's enough to buy them on the record date and wait until the end of trading. On the second day, you can sell the shares without worry; the right to the dividend has already been booked for you.
There is no catch; it's just necessary to realize that people are active on the stock exchange. The market price of shares usually rises as the record date approaches, and on the day after the record date (called ex-dividend date), when the right to the dividend no longer exists, the market price of shares usually drops by the net dividend (gross dividend minus withholding tax).
Companies traded on the stock exchange publish: the date of the general meeting (which decides on dividend payment), the record date (the day when owning shares is sufficient for a dividend claim), ex-dividend date (the date from which shares are traded without entitlement to dividends), and the date of dividend payment.
Dividend and Stock Market Price
Net profit and dividend policy naturally affect the market price of stocks, especially for companies that consistently (and in good amounts) pay dividends. These are commonly referred to as dividend stocks.
In the case of exceptionally good results, a company may resort to paying extraordinary dividends, which should have a positive impact on the market price of the stock. Conversely, a breach of a long-term dividend policy or even not paying any dividends can impact the market price of the stock negatively.
The advantage of owning shares in companies that pay dividends is that you don't have to worry too much about the current market price of the stock or its fluctuations. However, this assumes that it's not a collapse in the stock price due to poor results or that you don't need to liquidate the stocks quickly (and therefore sell at a loss). Simply put, you hold the stocks, get dividends, and hope for better days when the stock price rises again.
However, as a shareholder, it's crucial to exercise caution and monitor companies whose dividend policies may be unsustainable due to poor financial results or high levels of indebtedness. Falling into a dividend trap, where a company struggles to maintain or increase dividend payments, can lead to negative consequences for investors.
You Might Be Also Interested
- Investment vs Speculation;
- Investment Triangle Golden Rule;
- Stocks: Basics You Need to Know;
- Is Buying Stocks a Game of Chance?
- Bitcoin: A Comprehensive Guide;
- Investing in Gold as a Safe Haven;
- Price of Gold Surpassed the Historic Record from August 2020 (2023-12-04);
- Silver in Modern Society;
- Copper as a Barometer of the State of the Economy;
- Inflation: How to Protect Against It.
Based on the original Czech article: Co jsou dividendy a jak je získat.