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Dividends 101 - The Beginner's Step-By-Step Overview of How Dividends Work

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How a Company Pays Dividends and the Three Dividend Dates that Matter to You
Dividend Checks

Before a company can pay cash dividends to shareholders, it has to go through a legal checklist that includes declaring a declaration date, ex-dividend date, date of record, and distribution date. As an investor, you need to know what these represent.

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Companies that earn a profit can do one of three things: pay that profit out to shareholders, reinvest it in the business through expansion, debt reduction or share repurchases, or both. When a portion of the profit is paid out to shareholders, the payment is known as a dividend. For many investors, "living off dividends" is the ultimate goal (for more information about this, you can read the 10 Part Guide to Income Investing.

During the first part of the twentieth century, dividends were the primary reason investors purchased stock. It was literally said on Wall Street, “the purpose of a company is to pay dividends”. Today, the investor’s view is a bit more refined; it could be stated, instead, as, “the purpose of a company is to increase my wealth.” Indeed, today’s investor looks to dividends and capital gains as a source of increase. Microsoft, for example, did not pay a dividend until it had already become a $350 billion company, long after making the company’s founders and long-term shareholders multi-millionaires or billionaires.

 

The Process

Dividends must be declared (i.e., approved) by a company’s Board of Directors each time they are paid. There are three important dates to remember regarding dividends.

 

  • Declaration date: The declaration date is the day the Board of Director’s announces their intention to pay a dividend. On this day, the company creates a liability on its books; it now owes the money to the stockholders. On the declaration date, the Board will also announce a date of record and a payment date.

     

  • Date of record: This date is also known as “ex-dividend” date. It is the day upon which the stockholders of record are entitled to the upcoming dividend payment. According to Barron’s, a stock will usually begin trading ex-dividend or ex-rights the fourth business day before the payment date. In other words, only the owners of the shares on or before that date will receive the dividend. If you purchased shares of Coca-Cola after the ex-dividend date, you would not receive its upcoming dividend payment; the investor from whom you purchased your shares would.

     

  • Payment date: This is the date the dividend will actually be given to the shareholders of company.

A vast majority of dividends are paid four times a year on a quarterly basis. This means that when an investor sees that Coca-Cola pays an $0.88 dividend, he will actually receive $0.22 per share four times a year. Some companies, such as McDonald’s, pay dividends on an annual basis.

 

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