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Understanding Dividends

What Are Dividends?

A dividend refers to disseminating part of an organization’s earnings to a class of the organization’s shareholders. Its board of directors determines the dividends distributed by the organization. Thus, the board of directors determines the dividend yield of an organization annually.

Ordinary shareholders of an organization are qualified for dividend allocations as long as they purchased the stock before the ex-dividend date. Usually, dividends are paid out either in the form of cash, additional stock, or assets. Before an organization distributes dividends, it must attain approval from the shareholders who hold voting rights.

Typically, the organization retains most of the gains it generated, commonly known as the organization’s retained earnings. Retained earnings constitute the money utilized by the organizations for business activities taking place currently and in the future. The shareholders get dividends from the remaining organization profit.

Types of Dividends

There are three main types of dividends: cash dividends, stock dividends, and asset dividends. Cash dividend refers to an organization’s payment to its shareholders in the form of actual cash. When a company makes money, it can decide whether or not to pay out these surplus funds in cash (or other assets). Usually, the company makes the payment to shareholders electronically through wire transfer or direct cash or check.

A stock dividend involves paying each shareholder an equal amount of additional shares. For example, if every shareholder owns 100 shares and the company decides to pay a 2% stock dividend, then each shareholder will receive an additional two shares for every one share outstanding.

Nevertheless, companies pay out shareholders in stock dividends by issuing new shares in the organization. This form of payment is undertaken on a pro-rata basis meaning that the shareholders receive new stock based on the number of shares that they already own in the organization.

An asset dividend refers to a situation where there’s a distribution of the only organization’s assets to its shareholders. There are no restrictions on how organizations remunerate their shareholders. Therefore, it leads to the utilization of asset dividends. An organization can indemnify its shareholders by utilizing real estate, physical assets, and investment securities.

Issuance of Dividends

In most cases, organizations issue the shareholders with cash dividends. Also, organizations disseminate dividends in the form of assets or shares of companies. Different exchange-traded funds and mutual funds pay out dividends. Generally, a dividend can be viewed as a token reward that an organization pays out to its shareholder in return for investing in the organization’s equity. Most organizations get the dividend paid out to the shareholders from the net profits attained during the financial year.

Notably, there are times when organizations may still pay out dividends to shareholders even after not realizing the desired gains in a financial year, undertaken to maintain the organization’s reputation of giving its shareholders’ dividend payments regularly. Companies with such a good reputation are more attractive to investors.

The best payers of dividends to shareholders usually are large and established organizations that attain predictable profits. These organizations issue dividends regularly since they seek to maximize the shareholder’s wealth in different ways apart from the organization’s growth from its usual activities. Based on the observation of experts, organizations in the utilities, health and pharmaceuticals, banks and financial, oil and gas, and essential materials industry sectors regularly pay their shareholders dividends.

Further, the organization structured as real estate investment trust (REIT) and master limited partnerships (MLP) are usually amongst the top payers of dividends regularly attributed to their designation mandating that shareholders have specified distributions from the organization’s earnings. Also, funds such as exchange-traded funds and mutual funds typically have investment objectives that state the organization’s issue dividend payments regularly.

Some organizations don’t issue out dividends regularly. These are startups and organizations experiencing high growth found in the biotech and technology sectors, which occurs in the early stages of their development. Such organizations have high operating costs emanating from operational activities, business expansion, and research and development. Therefore, unable to remit dividends to shareholders.

Additionally, even organizations in the early to mid-stage of their product that generate a profit usually refrain from paying their shareholders dividends if their objective is to attain growth and expansion higher than the average. In such a case, all the profits achieved flow back into the organization’s business activities instead of dividends. On the whole, investors reap more when there’s an increase in a dividend stock.

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