Dividend

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Definition of a Dividend:

A dividend is the share of profits paid by a company to its shareholders. Companies are not required to pay dividends.

Detailed Explanation:

A company must decide how to spend the money earned from a profit. It may retain its earnings to reinvest in expanding its operations, or it may choose to share its earnings with its owners (shareholders) as dividends. The payment of dividends is not obligatory. A board of directors may decide one year to increase the dividend and in the next choose not to pay any dividend. Normally dividends are not paid when there is a financial problem and companies want to conserve their cash, but some very strong companies do not pay a dividend. These include: Alphabet, Inc. (Google); Amazon.com, Inc.; and eBay, Inc. (This is as of December 2016.) This may not be a sign the companies are in financial trouble. Instead, their boards recognize investment opportunities and choose to retain the earnings rather than issue more stock or borrow money to finance their growth. These companies are considered growth companies. In theory, an investor benefits when a company reinvests at a higher return than the investor could earn in another investment. 

Well-established companies normally pay a dividend. Their shareholders generally prefer minimizing their risk by not relying totally on the future growth of a company. An investment in shares of a company that pays a dividend provides investors with a combination of current income and the potential for long-term appreciation in the stock's value.

When are shareholders paid their dividends? Would I receive the dividend if I purchase a stock today that is paying its dividend tomorrow? The answer is "No" because it takes time to process transactions. The timing is best illustrated with an example. Assume Terrence owns 100 shares of Higher Rock stock. The board of directors declares a dividend of $1.00 per share to be paid on December 31st to all shareholders who own Higher Rock stock on December 15th. December 15th is the record date. Transactions take three business days, so an investor interested in receiving the dividend must purchase Higher Rock shares at least three business days before the record date. Two days before is the ex-dividend date. Dividends for the quarter will not be paid to the new owner because they actually take possession of the shares after the record date. Terrence owns Higher Rock shares on December 15th, so he is entitled to the dividend. But what if Terrence sells his stock to Thelma on December 13th? It takes three business days to complete a transaction, so Terrence would still own the shares if he sold them on December 13th, so he will still receive a check on December 31st. Thelma will miss the opportunity to earn a dividend on December 15th but will be eligible for future dividends if she continues to own the stock and Higher Rock continues to pay them.

Dividends can be quoted on a per share basis, or on a yield basis. Higher Rock's board announced a dividend per share of $1.00, so Terrence received $100 because he owned 100 shares. Investors are also interested in a stock's yield, or the percentage return based on the stock price. Higher Rock's dividend yield would be two percent if the stock's price is $50 per share. Yield is important when income-seeking investors compare potential investments. However, remember, a dividend is not guaranteed and the stock's price may decrease.

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