Types of Dividends

Date: 2015-10-07; view: 425.

Stock

Stock is ownership in a company, with each share of stock representing a tiny piece of ownership. The more shares you own, the more of the company you own. The more shares you own, the more dividends you earn when the company makes a profit. In the financial world, ownership is called equity. Businesses issue stock to raise money. They use this money to finance expansions, pay for equipment, and fund projects, etc. Corporations issue stock when they may need additional capital to operate successfully. The term for issuing stock to raise money is equity financing. The money received from investors who buy stocks is called equity capital. In the world of securities, the word "equity" usually refers to stocks. The other method of raising money is debt financing, which involves selling bonds. When companies make profits, they may reward their stockholders with pieces of their profits, known as dividends. Dividends are an incentive for investors to hold stocks. Stocks are grouped on the basis of their issuer's capitalization. "Cap" is short for capitalization, which is the market value of a stock. Capitalization gives a picture of a stock's size. You can calculate a stock's capitalization by multiplying its market price by the number of its shares outstanding ("outstanding" means in the hands of the public). For example, if Stock A has a present value of $20 per share, and there are one million shares of it in the hands of public investors, then Stock A has a capitalization of $20million. Some corporations issue both common and preferred stock. Each provides unique benefits to investors. Both common and preferred shareholders own a company, so the two types vary largely by rights. Common stock confers voting and pre-emptive rights. Preferred stock may trade voting and pre-emptive rights for dividends and a higher claim to liquidated company assets than common stock. Both common and preferred shareholders have the following rights and privileges (although preferred shareholders may have theirs restricted or applied only in certain situations).Owners of common stock have the right to vote on company matters. For example, they can vote on whether to allow a stock split, or whether the objective of the company should be changed. They cannot, however, vote on whether dividends should be distributed. A shareholder has one vote for each share owned. To cast their votes, most shareholders use a form of absentee ballot called a proxy. Shareholders also elect the management of the corporation. Preemptive rights may give shareholders the right to keep their proportionate ownership of the company. With preemptive rights, they can maintain voting control, share of earnings and share of assets. Preemptive rights let common shareholders buy new shares of stock before non-stockholders. Shareholders have the right to inspect the books and records of the company. They also have the right to sue the management for any unauthorized activities. Preferred shareholders are paid before common shareholders. If the corporation issuing the stock goes bankrupt and has to sell its assets, common stockholders will receive the assets, but only after all other creditors. Bondholders and preferred stockholders receive them first. Preferred stock pays a fixed dividend that is specified and set down in advance. Unless the stock is retired or called back, it will continue paying dividends forever. Preferred stock is usually issued with a $100 par (face) value. The dividend payments are a fixed percentage of the par. For example, if the par value of a stock share were $100 with a 6 percent annual dividend rate, the annual dividend would be $6 on that share. In recent years, some companies have also begun issuing preferred shares with variable rates tied to interest rates.

Look through the text once again and answer the following questions:

1. What is stock?

2. When do corporations issue stock?

3. What bases are stocks grouped on?

4. How can a stock's capitalization be calculated?

5. What rights do shareholders posses?

The term dividend usually refers to cash distributions of earnings. If a distribution is made from sources other than current or accumulated retained earnings, the term distribution rather than dividend is used. However, it is acceptable to refer to a distribu­tion from earnings as a dividend and a distribution from capital as a liquidating dividend. Generally, any direct payment by the corporation to the shareholders can be considered part of dividend policy.

There two main types of dividend: common stock dividend and preferred stock dividend.

Common stock pays dividends in three forms: cash, stock and property. Let's take a look at each one. Cash dividends are those that are paid out in cash form. They are treated as investment income and are taxable in the year they are paid.

Stock dividends are dividends paid out in the form of additional stock shares in the corporation, or shares of a subsidiary corporation. They are usually issued in proportion to shares owned. For example, for every 100 shares of stock owned, a 4 percent stock dividend will yield four 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 company by conserving its cash and they benefit the shareholder by increasing his/her number of shares of the company.

Property dividends are paid with assets owned by the issuing company. Property dividends are usually paid in the form of products or services that the corporation produces. Often the corporation, when paying property dividends, will use securities of other companies owned by the issuer.

Preferred stock further divides into four types: cumulative, non-cumulative, participating and convertible. Cumulative preferred stock accords its owner a continuous claim to his or her dividends. Any unpaid dividends accumulate until the corporation resumes paying them. Since the cumulative preferred owner is entitled to all past and present dividends, he or she is paid before common shareholders once payment is resumed. If the board of directors suspends dividends, the shareholder still has a claim on them. Non-cumulative (straight) preferred is the opposite of cumulative preferred: it doesn't confer a steady claim on dividends in the event of a dividend suspension. Shareholders of this type may not be paid any missed dividends prior to payments being made to the common shareholders.

Participating preferred shareholders receive extra dividends over their nominal ones when the company makes an extra profit and the board of directors declares dividends. Convertible preferred stock may be converted to a certain number of shares of common stock. Preferred investors who want the opportunity to share in the appreciation of the company's common stock may find this option attractive. Preferred stock may carry a call provision. This means that the issuing company can repurchase the stock from the shareholders. Though preferred stock is usually called at par value, some call provisions actually tack on a premium. Because of the steady dividends accorded to preferred shareholders, call provisions are not usually advantageous to them, despite any premiums. However, a corporation may use calls as a way to eliminate dividends, thus increasing earnings for common shareholders.

When a firm declares a stock split, it increases the number of shares outstanding. Because each share is now entitled to a smaller percentage of the firm's cash flow, the stock price should fall. For example, if the managers of a firm whose stock is selling at $90 declare a 3:1 stock split, the price of a share of stock should fall to about $30. A stock split strongly resembles a stock dividend except it is usually much larger.

The decision whether or not to pay a dividend rests in the hands of the board of directors of the corporation. A dividend is distributed to shareholders on a specific date. When a dividend has been declared, it becomes a liability of the firm and cannot be easily rescinded by the corporation. The amount of the dividend is expressed as dollars per share (dividend per share), as a percentage of the market price (dividend yield), or as a percentage of earnings per share (dividend payout).