Posted by The TaxAdvocate Group, LLC

Dividends and Other Corporate Dividends

Dividends and Other Corporate Dividends

The dividend is one of the primary ways in which companies communicate their financial health and shareholder value. By distributing the profits, companies are announcing a positive future and strong performance. The ability and readiness of a business to pay stable dividends over a long period and even to constantly increase them give a good picture of its fundamentals.


What is a Dividend?

A dividend is a portion of the retained earnings and profits that a company pays to its shareholders. When a business generates profits and accumulates retained earnings, those profits can be reinvested in the business or paid out to shareholders. The yearly dividend per share, distributed by the share price, is the dividend yield.


Understanding Dividends

Shareholders must approve dividends with their voting rights. While cash dividends are the most common, they can also be issued in stocks or other property. Along with businesses, many mutual funds and exchange-traded funds (ETFs) also pay dividends.

A dividend is a symbolic reward paid to shareholders for their investment in a company's equity and typically comes from its net profits. While most of the profit is held within the company in the form of retained earnings, which is money that will be used in the company's current and future business activities, the rest can be allocated to shareholders under the form of dividends. Sometimes companies can continue to pay dividends even if they are not making enough profit. They can do this to maintain a well-established history of regular dividend payments.

The board of directors can choose to issue dividends over several periods and at different payment rates. Dividends can be paid regularly, for example, monthly, quarterly, or annually. 

Companies can also issue special non-recurring dividends, individually or in addition to a planned dividend. Building on solid business performance and a better financial outlook, Microsoft Corp. (MSFT) declared a special dividend of $ 3.00 per share in 2004, well above the normal quarterly dividends of $ 0.08 to $ 0.16 per share.

How a Dividend Works

The dividend amount is determined per share and will be paid in equal parts shareholders of the same class (preferred, common, etc.). The board must approve the payment of directors. When a dividend is declared, it will be paid on a certain date, called a payment date.

Stages of its Operation:

  • The company generates profits and retained earnings.

  • The management team decides that some excess profits should be paid to shareholders (rather than reinvested)

  • The board approves the proposed dividend.

  • The company announces the dividend (value per share, payment date, registration date, etc.)

  • The dividend is paid to the shareholders.


Different Forms / Types of Dividends

There are several forms of dividends paid to shareholders:

Bonus Share (Stock Dividend): Bonus share is also called a stock dividend. These shares are issued by the company when they have little money, but still want to satisfy investors. Each shareholder receives a certain number of additional shares, depending on the number of shares the shareholder initially held. For example, if a person owns twenty shares of company A and the company declares a free issue of shares equal to 1 for every 2 shares, that person will receive ten additional shares in their account. From the company's point of view, the number of shares and its capital increase of 50% (1/2 share). 

  • Market price, DPS, EPS, etc. will be adjusted distributively. In this case, the company will also keep the profit when the shareholder receives the dividends. An investor who wants a cash return can sell his investments in the secondary market. This is also called profit capitalization.

  • Cash Dividend: Is perhaps the most common form of a dividend. Shareholders are paid in cash per share. The board of directors will notify the payment of dividends on the date of the declaration. Dividends are allocated to shareholders on the registration date. Dividends are usually issued on the date of payment. But to distribute cash dividends, the company must have positive retained earnings and enough money to pay dividends. 

  • Liquidating Dividend: When the company returns the initial capital contributed by shareholders in the form of a dividend, it is a liquidating dividend. It is often a sign of business closure.

  • Property DividendScrip Dividend: The scrip dividend is an invoice which must be paid subsequently to the shareholders. This dividend is used when the business does not have adequate funds to issue dividends.

  • Share Repurchase: This occurs when a company buys its shares in the market and reduces outstanding shares. This is seen as an alternative to paying dividends because the money is returned to investors in another way.

  • The company makes payment in the form of an asset in the property dividend. The asset can be any of these items of equipment, inventory, vehicle, or any other asset. The value of the asset must be updated to its fair value when issuing a real estate dividend.

Advantages of Dividend Payment

Paying dividends to investors has several advantages, both for investors and the company:

  • Benefits without Selling: Investors who invest in dividend-paying stocks do not have to sell their stocks for participating in the stock increase. They get monetary benefits without selling the shares.

  • Bird-In-Hand Fallacy: This theory states that shareholders prefer the certainty of dividends over the possibility of higher capital gains in the future.

  • Information Signaling: When a company announces dividends' payment, it gives a strong signal on the company's prospects. Businesses can also benefit from the additional publicity they receive during this time.

  • Investor Preference For Dividends: Investors are more interested in a company that pays stable dividends. This guarantees them a reliable source of profit, even if the stock price falls.

  • Stability: Investors prefer companies with a history of paying dividends, as this positively reflects their stability. This indicates predictable returns for investors and therefore makes the business a good investment.

  • Temporary Surplus Money: A mature business may not have attractive ways to reinvest the money or have lower research and development costs. In this scenario, investors prefer the company to distribute excess cash to reinvest the money for higher returns elsewhere.

Disadvantages of Payment Dividends

The payment of the dividend also has several disadvantages:

  • Clientele Effect: If a company that pays dividends is unable to pay dividends for some time, there may be a loss from a former client who preferred regular dividends. These investors can settle short-term stocks.

  • Logistics: Paying dividends requires a lot of registration by the company. The company must ensure that the right shareholder receives the dividends.

  • Reduced Retained Earnings: When a company pays dividends, its retained earnings decline. Debt and unforeseen expenses can increase if the company does not have sufficient cash flow.


Conclusion

Because dividends are important to investors' satisfaction, the company must diligently decide when and how dividends will be paid. It would be best if you also considered the pros and cons of dividends before setting dividend policy.



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