How Do Dividends Work?

Written by frank girard
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How Do Dividends Work?
Stockholders receive a part of a company's profit when they receive cash dividends. (Stock Market image by Paul Heasman from Fotolia.com)

When individuals purchase stock in a company, they become part owners in the company. When the board of directors of a company announces a stock dividend, the company is paying cash to the investors or stockholders. Shareholders receive part of the company's profits when they receive dividend payments.

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Decision to Pay Dividends

According to Investopedia, corporations decide to pay dividends when it is no longer financially beneficial for them to reinvest profits back into the company. When companies expand rapidly and have many new projects that need financing to help them continue to grow, the financial strategy is to reinvest earnings. When a company matures and new projects are no longer on the horizon that will help it grow, increases in stock prices slow down. Dividends help retain investors at this point in a company's growth cycle.

How Do Dividends Work?
When a company matures, a decision is often made to pay dividends. (Money image by Pavel Shchegolev from Fotolia.com)

Significance of Dividends

Decisions to pay dividends communicates to shareholders that the company has reached a stage when it is more profitable to the shareholder to receive a distribution of the profits in the form of a dividend payment than to expect the price of the company's shares to increase in order to realise a profit. According to Investopedia, when a company decides to pay dividends, it is an indication that the company is financially healthy.

Dividend Payments

According to eSSORTMENT, several dates are important in determining a shareholder's eligibility to receive a declared dividend payment. After the Board of Directors announces that dividends will be paid, a trade on any newly purchased shares must be settled three days prior to the record date, according to SEC rules. The distribution date is the date the dividend checks are mailed to shareholders and can be a few weeks after the record date.

Determination of Dividend Amount

The amount of the dividend that a shareholder receives is determined by the number of shares the stockholder holds as of the record date, according to eSSORTMENT. The dividend amount is sometimes noted as X cents per share. Dividends can be paid out quarterly, semi-annually or annually. If the company has just concluded a profitable deal, the board of directors might announce a special dividend payout.

Dividend Policy

According to Investopedia, the company's board of directors makes the decision to pay dividends. The board of directors determines the percentage of earnings that the shareholders will receive as a dividend. Most dividends are paid quarterly, but according to Investopedia, the company is not bound to pay dividends each quarter.

How Do Dividends Work?
The company's board of directors makes the decision to pay dividends. (stocks and shares image by Andrew Brown from Fotolia.com)

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