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.

More About Dividends

What Are Two Main Types Of Dividend Policies?

Cash dividends,  are those paid out in currency. This is the most common method of sharing corporate profits with the shareholders of the company.They are form of investment income and are usually taxable to the recipient in the year they are paid. For each share owned, a declared amount of money is distributed. So if an investor owns 100 shares and the cash dividend is $1.50 per share, the holder of the stock will be paid $150.

 
Stock or scrip dividends are paid out in the form of additional stock shares of the issuing corporation instead of paying in cash.They are usually issued in proportion to shares owned (pro-rata). If the payment involves the issue of new shares, it’s same as stock splits, which will cover later, in that it increases the total number of shares while lowering the price of each share without changing the market capitalization of a company.

Ratios Commonly Used To Gauge The Sustainability Of A Firm's Dividend Policy: Dividend Cover And Payout Ratio:

 
Dividend cover of a company is important factor to understand about an investment, and see if a company has a stable payment policy. Do they increase their payments in an orderly and regular way, are payments made at a constant rate and will the firm be able to maintain these payments? 

 
One measure used to help answer these questions is a ratio known as dividend cover:

 
Dividend Cover = Earnings Per Share divided by Dividend Per Share

 
The inverse of this ratio is the proportion of earnings that belong to ordinary shareholders which are distributed to them, better known as the dividend payout ratio. If a company has a dividend cover ratio of 1.0, it pays out all earnings in dividends. This means that should earnings fall, the company might be forced to cut annual dividend payments. 

 
Many firms use annual dividend payments as a signal to shareholders and the market of confidence, so in the short term, directors will be reluctant to reduce payments, unless the firm is in trouble.


How Is Dividend Yield Calculated?

Dividend yield is used for comparing the relative attractiveness of various income stocks, or stocks that pay dividend. It tells you, in a percentage terms, what you can expect to profit in a year if you buy that stock. It is useful because it allows us to compare it, not only with other stocks, but with other investments such as bonds or certificates of deposit.

 
Formula is: Dividend yield =  Annual dividend / Current stock price. 

 
So if company has a price 20$/share and it pays 2$/share dividend, dividend yield will be: 2$ / 20$ = 10%.