What you need to know about dividends

When the board of directors of a corporation decides to pay out its earnings or part of its earnings in dividends, all its common shareholders have a right to receive them. If the board of directors decides not to declare a dividend, the shareholders receive nothing. Companies are not legally required to pay dividends even if they are profitable and have paid them in the past. In contrast, companies are legally required to pay interest to their bondholders on their debt. This is an important distinction for people who rely on regular income from their investments.

Declaration of Dividends

If the receipt of dividends is important to you, you need to be aware of these four dates:
* Date of declaration is the date on which the board of directors declares dividends.
* Date of record is the date that determines which shareholders are entitled to receive the dividends. Only shareholders owning shares of the company on the date of record are entitled to receive dividends. If shares are purchased after the record date, the owners are not entitled to receive the dividends.
* Ex-dividend date is two business days before the date of record. Stocks traded on the ex-dividend date do not include the dividend. When common stock is bought, the settlement takes three business days to be completed. Thus, if the record date for a company’s dividend is Friday, the ex-dividend date is the preceding Wednesday. Investors who buy these shares on Tuesday (the day before the ex-dividend date) receive the dividend because the transaction is recorded in the ownership books for that company in three working days.
* Payment date is the date on which the company pays the dividends.

Companies generally make their dividend policies known to the public. Because investors use dividend payments, rightly or wrongly, as a yardstick or mirror of a company’s expected earnings, changes to dividend payments can have a greater effect on the stock price than a change in earnings does. This phenomenon explains the reluctance by management to cut dividends when earnings decline. Similarly, a lag in increasing dividends might occur when earnings increase because members of management want to be sure that they can maintain any increases in dividends.

Shareholders who rely on income from their investments generally purchase the stocks of companies that have a history of paying regular dividends from their earnings. These companies tend to be older and well established; their stocks are referred to as income stocks or blue-chip stocks. Table 2–1 discusses the importance of dividend-paying stocks.

Young companies that are expanding generally retain their earnings; their stocks are referred to as growth stocks. Growth stocks appeal to investors who are more interested in capital appreciation.

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