How The Dividend Is Paid

When the board of directors declares a dividend, which is on the declaration date, they also specify the date of record and the payment date. The date of record is the date when a stockholder must be a registered owner of the stock—a holder of record—to receive the dividend. The payment date (aka payable date) is when payment is actually made—generally about 3 weeks after the date of record.

Because it takes 3 business days to settle a stock trade, the date of record determines the ex-dividend date, which is 3 business days earlier. The ex-dividend date is the 1^st day in which the stock trades without the recently declared dividend. In newspaper listings, a stock is marked with an x to indicate that it is ex-dividend. An investor who buys the stock during the ex-dividend period will not be entitled to the recently declared dividend.

The price of the stock increases steadily by the amount of the dividend until the date of record, then drops by the same amount on the ex-dividend date. This happens because investors are willing to pay more if they are expecting to receive the dividend, which offsets the increased price. Moreover, open buy and stop sell orders are also usually reduced by the dividend amount on the ex-dividend date.

Dividend Yield and the Dividend Payout Ratio

Although the dollar amounts of dividends are specified by the board of directors, investors often want to know how the dividend compares with other investments. The dividend yield, which is the dollar amount of the dividend divided by the common share price, yields a percentage allowing the investor to compare the stock to other investments, especially if the investor is primarily concerned about current income.

Dividend Yield = Annual Dividends Per Share / Current Stock Price

Example: If a stock pays a $1 quarterly dividend and the current stock price is $60 per share, then:

Dividend Yield = $1 x 4 / $60 = $4 / $60 = 6.67%

Another concern of investors when considering a dividend-paying stock is whether the company can continue paying the dividend or even increase it over time. A company can only pay a dividend over an extended period of time if it is highly profitable. If a company is only minimally profitable, it will probably withhold the payment of dividends during economic downturns. And a company can only increase the dividend if its earnings grow. The dividend payout ratio, which is the dividend per share divided by the common earnings per share, is a good indicator of whether a company can continue to pay the dividend and even increase it in the future.

Dividend Payout Ratio =

Dividend Per Share ───────────────────── Common Earnings Per Share

For example, if a company earns $8 per share and pays $1 per share quarterly as a dividend, then its:

Dividend Payout Ratio = 1 x 4 / 8 = 4/8 = 50%.

If a company’s dividend payout ratio is greater than 60%, especially over a long time period, it will probably not increase its dividend for the foreseeable future, and it may have to lower it or even suspend it in hard economic times because most of its earnings are being paid out as dividends.