Dividends are stockholders' shares of company profits. Taken from revenue, generally a publicly-owned company will hold a portion of the profit, referred to as retained earnings, and distribute the remainder among shareholders on a pro rata basis in proportion to the number of shares owned. Stock companies have dividend policies governing declaration dates, date of records, ex dividend dates, and payment dates, i.e., when and how dividends are distributed.
Declaration and Record Date
After considering retained earnings for expansion, projects, and working capital and following the direction of management, the board of directors of a corporation sets the dividends per share or DPS rate to be paid to stockholders. This is known as the declaration date; the board "declares" a dividend. Shortly thereafter, the company sets a record date. Shareholders who own stock on the record date are eligible for a dividend payment based on the number of shares owned on the record date.
Ex Dividend Date
When a company sets the record date for the dividend, the National Association of Securities Dealers or the exchange on which the company is traded, sets an ex dividend date. According to the U.S. Securities and Exchange Commission, the ex dividend date is generally two business days prior to the date of record. Days when the markets are closed, e.g., Saturday and Sunday, do not figure into the ex dividend date period. During this short interval between the ex date and record date, a stock trades without the new owners acquiring rights to the current forthcoming dividend. However, stocks purchased during the two-day lapse are eligible for the next dividend, a quarter of a year away, if held until the following record date.
Knowing how share dividends work prevents investors from losing out on earnings. For example, suppose the board of directors of the Gadget Corporation declares a dividend with a record date of April 10. Joe Moneymaker owns 100 shares of stock in Gadget and has heard that the dividend will be a significant increase over last quarter. Mr. Moneymaker buys 1,000 additional shares of stock on April 12, not knowing how dividends work. On April 10, the record date, he officially owns only 100 shares. Even though he may hold title to 1,100 shares of Gadget stock when the dividend is paid, on the record date he owned 100 shares, thus he will receive a DPS for only 100.
Setting an ex dividend date for stock shares prevents increased volatility in share prices caused by investors who simply buy and sell to reap the rewards of dividends. Thus, to earn dividends on company stock, the shareholder must hold ownership on the date of record. The dividend distribution date, also called the payment date, is the day when shareholders are paid. Generally, dividends are paid in cash. However, a dividend can be paid in additional shares of company stock.