Stock Dividends 101
June 4, 2009
When doing research on an individual stock, one important thing to look at is if it pays dividends. These are payments that a company makes to its investors on its outstanding shares. These dividends are paid out on both common and preferred shares. Due to the structure of preferred stock, those shares must be paid before any dividends are paid to common shareholders.
Dividends come out of the profits of a company. When that company takes the profits and puts it back into the research and development or expansion of the organization, it is called “retained earnings.” When the profits are passed through to the shareholders, this is called a dividend. Generally, dividends are paid in cash, but a “stock dividend” is also possible.
Dividends are usually paid out on a quarterly basis. The board of directors for each company sets the “dividend policy.” They can increase, decrease or eliminate it altogether based on the health of the company. The board of directors are the only ones that can set or change the policy.
If a company sells part of a portion of the organization and receives a lump sum in cash, it may choose to issue some or all of this cash in the form of a special dividend. These are rare occurrences that involve a substantial amount of money.
Important Dividend Dates
Declaration Date – This is the date the board of directors announces it will pay out a dividend.
Ex-Dividend Date – This is the last trading day to buy shares and be considered a shareholder of record when the dividend is paid. For example, if the Ex-Dividend Date is May 15th, someone who buys shares on May 16th will not be eligible to receive that dividend payment.
Record Date – Shareholders must properly register their shares by this date in order to receive the dividend (this is all automated now, and is handled by the brokerage firm you use).
Payment Date – The date the dividend payment is made.
Taxation of Dividends
For the 2009 tax year, the maximum tax rate on “qualified dividends” is 15%. This rate is 0% for those whose taxable income falls below the 25% tax bracket. A “qualified dividend” is one in which the investor “must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date,” as the IRS explains in Publication 550. In English, you must have owned the stock for at least 60 days before ex-dividend. If the dividend is not qualified, it is taxed as ordinary income.
The Dividend Yield is possibly the most important piece. To calculate this number, divide the total dividend payout for the year by the current share price. For example, if the annual dividend is $1 per share and the price of the stock is $50, the dividend yield would be 2%. The higher the dividend yield, the better, especially in situations where the stock price is coming down. The yield helps offset some of the loss in value.
There will be situations in which a company has an incredibly high dividend yield. This is not necessarily a good thing. The stock may be taking a serious hit due to some bad news, such as an earnings miss or the loss of a big contract. Chances are, the board will make adjustments to that dividend in the near future.
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