The simple answer is that Dividends are payments by a company to its shareholders. For more detailed answers, about cash dividends please find several definitions below. Please also refer to our stock dividend, dividend reinvestment plan and cash stock option pages.
The part of the profits made by a company that it pays to its shareholders.
A distribution wealth to the shareholders of a company, made out of the earnings during a period (year, half year, quarter or month).
A taxable payment from a company to its shareholders.
Why do companies pay dividends?
Companies are not required to pay dividends. Companies that chose to do so, often have grown sufficiently and see no opportunities to invest in themselves to obtain growth. So rather than retaining the money, they give it to the shareholders.
Start up companies however, might chose to retain their income and use it to grow their business, meaning that shareholders will not receive payments in cash.
A third option to increase value for the shareholders is to pay off the debt of the company (especially debt with unattractive terms an conditions).
A company could also chose to use its profits to buy back its own stock (and by doing so increasing the value of the remaining outstanding shares).
Why are investors interested in receiving dividends?
Investors seek to maximise the value of their money. They might chose to put the money in a bank account and receive interest on it. But if they think certain shares will pay them a higher rate than the interest on a bank account, they might want to invest their money in those shares. The difference between putting your money in a bank account and investing it in shares is the risk you're taking. When putting money in a bank account an investor knows beforehand how much interest they are going to get. When investing in securities, an investor has to take a gamble and wait and see how well the company is going to perform in the coming period and how much of the profit the company is transferring back to its owners (the company could decide to not pay a dividend at all).
Declaring a Dividend
Ex (Dividend) Date
CUM Dividend Date
This is the day on which the dividend is acutally going to be paid.
The dividend yield is a ratio which shows how much a company pays in in dividends relative to its share price. Put differently: it is the annual dividend per share divided by the price per share.
For example; Company A's shares are trading at GBP 50 per share and Company B's shares are trading at GBP 100 per share. Both companies announce an annual divided of GBP 5 per share.
Dividend Yield = Annual Dividend per share / price per share.
Dividend Yield A = 5 / 50 = 0.10 = 10%
Dividend Yield B = 5 / 100 = 0.05 = 5%
An investor would prefer to buy shares in Company A.
There are two sides of Dividend Income:
1. Dividends are paid out of the income of corporations. Income of corporations is the revenues of the company minus the cost of sales, operating expenses and taxes over a given period of time. What is left is available for reinvestment and dividends.
2. Dividens themselves can be part of an individual's or entity's income. In that case an individual or an entity holds shares of (another) company and receives income in that way.
The actual payment of a dividend. Often the cash settlement takes place electronically via your bank.
Price per earnings ratio
A ratio that shows the valuation of the shares against the earnings per share (EPS) of the company
Put differently: it is the current price per share in the market divided by the Earnings of the Company per share (EPS).
For example; Company A's shares are trading at GBP 50 per share and Company B's shares are trading at GBP 100 per share. Both companies announce Earnings per share of GBP 5 per share.
Earnings per share ratio = Price per share / Earnings per share.
Earnings per share ratio A = 50 / 5 = 10
Earnings per share ratio B = 100 / 5 = 20
An investor is willing to pay a multiple of 10 times the earnings per
share for Company A's shares and a multiple of 20 times the earnings per share for Company B's shares. Investors buying shares in Company B have higher growth expectations of Company B than of Company A.
Effects of a Dividend on the share price
Let's for example assume the following:
1) the investor holds 100,000 shares in company "ABC" before the event takes effect
2) the market price (written in Green) of the shares before the event = EUR 5.00
3) the nominal value of the shares before the event = EUR 1.00
4) the company announces a Cash Dividend of EUR 0.50 per share.
In the example the shareholder will keep all his 100,000 shares and receive a cash payment of EUR 35,000 while the nominal value of the shares remains the same and the market value of the shares drops from EUR 5.00 to EUR 4.65 .
Total value before the exdate of the event: 100,000 x EUR 5.00 = EUR 500,000
Total value after the exdate of the event: 100,000 x EUR 4.65 = EUR 465,000 (+ EUR 35,000 in cash).
The Share Value decreases roughly with exactly the same amount as the cash dividend. (this makes sense because one day before the cash dividend went ex, the shares were traded with the entitlement to the dividend whereas on the exdate the are no longer carrying the entitlements. In total no value is lost or made. The nominal value of the shares is not affected.
For more effects of other corporate actions events on the value of the share price please refer to this site: Effects on the shareprice
Process of a Cash Dividend
In terms of corporate actions, dividends are mandatory events. This means that the shareholder does not have to make a choice or to take any action. The money will be paid to them automatically.
There are a few steps that will usually be followed:
1. Acoountants and Controllers of a firm propose a Divididend amount to be paid
2. Board of Directors declares a cash dividend, the amount and the important dates
3. In many cases a Paying Agent (a financial institution specialised in the administrative operations of handling and paying cash dividends) is appointed.
4. The information is being made public in announcements in for example newspapers or in electronic media.
5. On the Ex date the shares trade without the entitlements to the dividend
6. On the Record date the company or the paying agent appointed by the company looks at the records of the company to see who the owners of the company are.
7. On the Pay Date the cash proceeds are being settled on the accounts of the eligible holders of the stock
8. Claims between eligible and non-eligible shareholders need to be settled. For more information about claims, please visit our CLAIMS page. Claims processing is usually being done automatically by custodians and broker dealers.
9. Tax vouchers will be issued and these need to be collected by the investors
10. Often, the cash dividend will be forexed back into the base currency of the (global) investor.
11. The (global) investor has to pay the taxes in his own country (and see if there are any double taxation treaties in place between the country of his domicile and the country he was investing in.
12. All the books and accounts from all parties down the chain from company to investor need to be adjusted and reconciled.
There are many tax considerations to make depending on the country an investor is domiciled and the country they are investing in. Besides that, tax legislation has the habit of being changed constantly, so investors are advised to consult their own tax advisors at all times.
Below is an example of how the Tax Department in the United Kingdom treats taxation on Dividends for the year 2010-11.
You pay tax at different rates on UK dividends (income from UK company shares, unit trusts and open ended investment companies) than you do on other income including wages, profits from self-employment, pensions and interest from savings, such as bank and building society interest.
Dividend tax rates 2010-11
There are three different Income Tax rates on UK dividends. The rate you pay depends on whether your overall taxable income (after allowances) falls within or above the basic or higher rate Income Tax limits.
The basic rate Income Tax limit is Ј37,400, and the higher rate Income Tax limit is Ј150,000, for the 2010-11 tax year.