Should The Company Pay A Dividend?

Common Stock Dividends
There are 2 ways that investors can earn a profit by buying stock: by buying the stock low and selling it higher, and by receiving dividends. While most companies—especially small, growing companies—do not pay a dividend, most large, profitable companies do by necessity, because there is a limit to how large a company can grow, and so the only way to maintain its stock price is by paying a dividend.


However, there are several advantages to stocks paying a dividend over those that don’t. Dividend-paying stocks provide a more certain income than what price appreciation alone offers. When the stock market declines, holders of dividend-paying stocks still receive an income, and the dividend helps to maintain the stock price even in a down market. And, often, the dividend plus the capital gains of a dividend-paying stock is greater than the capital gains of many stocks that do not pay a dividend. In fact, dividends have accounted for about 40% of the total return of the stock market since 1928!

Should The Company Pay A Dividend?

Whether a dividend will be paid depends on the profitability of the firm. While a firm does not have to earn profits to pay a dividend, it would generally be a bad decision for an unprofitable firm to pay dividends. And without profits, the future payment of a dividend would be in jeopardy.

The board of directors decides if and when a stock dividend will be paid, and how much. The board will generally consider the company’s financial position, both now and in the future, and the opportunity costs of paying a dividend. If the company can use the money to grow faster, then a dividend probably will not be paid. But if a company is both large and profitable, then it could pay some portion of its earnings as a dividend, since it becomes more difficult for a large company to grow ever larger. Hence, without the payment of a dividend, investors will shun the stock, since there is little chance to profit from price appreciation, and the stock’s price will collapse.

Besides size, the largest factor in considering a dividend payment is the company’s common earnings per share (EPS), which is the after-tax income of the company minus the dividends paid to preferred shareholders divided by the number of common shares outstanding.

Earnings Per Share = (Net Profit – Preferred Dividends) / Number of Outstanding Common Stock Shares

If the common earnings per share is high and likely to remain high, and if the company is too large to grow much larger, then the board of directors will probably decide to pay a dividend.

Classification Of Common Stock - Par Value And Stated Value

Classified Stock

Some companies issue different classes of stocks, and thus, are said to have a complex capital structure, or a multiple capital structure, which generally differ by voting privileges. This is most often done so that the founders of a company can retain control of their company by retaining the class of stock with the greatest number of voting rights. Most often, these different classes are referred to as Class A and Class B stock; however, which one has the greater voting rights may differ. For instance, Google has 2 classes of stock. Class B gives the holder 10 votes per share compared to the 1 vote for Class A. The 2 founders of Google and its CEO at the time of Google's IPO held the Class B shares while selling the Class A shares in a Dutch auction. Berkshire Hathaway issued a Class B stock that sold for far less than the Class A stock, which is currently above $100,000 per share, so that smaller investors could purchase some shares.

The different stock classes may also differ in dividends or liquidation priority. The share classes are defined in the corporate charter and bylaws.

Classification of Common Stock

Authorized shares are the shares that have been authorized by the charter when the corporation was formed. Issued shares are authorized stock that has been sold to investors. Issued shares and unissued shares make up all authorized stock. Outstanding stock is stock that is owned by investors. All outstanding stock has been issued, but sometimes a company will buy back its own stock, which then becomes treasury stock, which reduces the number of outstanding shares.

Authorized Shares = Issued Shares (sold to investors) + Unissued Shares
Issued Shares = Outstanding Stock (held by investors) + Treasury Stock (stock bought back by company)

Treasury stock is stock that had been issued by the company, but was bought back by the company. Treasury stock has no voting rights, does not receive dividends, is not used in the computation of earnings per share, and is no longer outstanding stock. Companies buy back their stock for any of the following reasons:

• to increase the market value of each share by limiting supply;

• to provide stock options and bonuses for officers and employees of the company;

• to have additional shares for the acquisition of another company;

• or to prevent a takeover by another company.

Par Value, Stated Value, Legal Capital

Par value is the value assigned to a share of stock when it is authorized, and is much less than its expected market value. Sometimes a stock will not have a par value, but will have a stated value in the corporation's financial records. Par and stated values set the minimum requirement for legal capital, which is the number of shares of outstanding stock multiplied by the par or stated value of each share. A corporation cannot pay dividends or buy back its stock, if doing so reduces the amount of legal capital below the minimum required by state law. Par value is more, however, for preferred stock, because they pay a fixed dividend that is a set percentage of the par value.

Why do Stocks have Par Value or Stated Value, and why is this less than the Market Price?

When a company first becomes incorporated, the state of incorporation must approve the number of shares of stock that the corporation is authorized to sell—authorized stock, or capital stock. Many states require that the stocks also have a par value, or nominal value, to provide a minimum amount of legal capital to pay creditors. The legal capital is equal to the par value multiplied by the number of shares of outstanding stock, which is the number of shares currently held by investors. The corporation is not legally permitted to pay dividends or buy back its own stock, if doing so reduces the amount of legal capital below the required minimum. The par value is printed on each stock certificate. The par value of each stock is also changed accordingly by stock splits. A 2-for-1 split, for instance, would halve the par value.

The par value is often $1 or less, which is much less than the market price or the expected market price of the stock. The par value is set low, because the stock cannot be issued for less than par value. If par value were higher and if the demand for the stock was less than anticipated, the corporation would be unable to sell the number of shares that it planned, since it would not be able to lower its price below par value in order to increase demand for its stock.

The par value of preferred stock is much higher than common stock because preferred stock pays a fixed dividend that is a designated percentage of par value.

No-par stocks have no par value printed on its certificates. Instead of par value, some states allow no-par stocks to have a stated value, set by the board of directors of the corporation, which serves the same purpose as par value in setting the minimum legal capital that the corporation must have after paying any dividends or buying back its stock.

If a corporation's stock has neither par value nor stated value, then the legal capital required is equal to the total amount received when the stock was first issued.

Basic Concepts Of Common And Preferred Stocks

Stocks, which represent ownership in a corporation are, and have been, one of the best investments one can make. The potential for profit is much greater than with guaranteed investments or interest-paying investments.

The main benefits of corporations over sole proprietorships and partnerships are that:

• its owners—stockholders—are liable only for the amount invested;

• the corporation can raise large amounts of money through the sale of stocks and bonds;

• complete control is vested in a board of directors, which the stockholders choose through voting.

The main disadvantage is that a corporation is carefully regulated by law, and must publish and distribute numerous reports to stockholders and various government agencies.

Corporations are business entities that operate under a charter from a state and raise capital by selling stocks and bonds, a form of capitalization.

Stocks are equity capital, giving the owners of stock a part ownership in the corporation, and bonds are debt capital. Bond holders lend money to the corporation by buying their bonds.

Total capitalization is the sum of equity and debt capitalization.

The net worth or shareholders’ equity is the difference between total assets and total liabilities of the corporation.

Legal Rights Of Common Stockholders

Common stockholders have the following legal rights:

• The right to receive stock certificates as evidence of ownership.

• The right to vote at stockholders’ meetings.

• The right to receive any declared dividends, and to sell the stock.

• The right to information and to receive financial reports about the company.

• Sometimes they may have the right to buy newly issued shares of stock by the company before the shares are sold to the public, so that current owners can maintain their proportionate interest in the company, if they so choose. Whether they have this privilege is determined by law or by the company's charter.

Stocks & Shares - Common Stock

Type Of Securities - Common Stock

 

Common stock, as the name imply, is a simple stock that has been issued by the corporation and is publicly traded. It is a form of corporate equity ownership and it is a type of security. It is called "common" to distinguish it from preferred stock. Stock represents a claim on the company's assets and earnings. The more stock you are holding, the greater is your ownership stake in the company. 

People that buy them can expect two types of profit. One is capital appreciation, which represent a profit that is made if you sell a stock at a higher price than you had bought. The other form of profit is trough dividends. Dividend represent a part of the companies profit, that management choosed to pay to the shareholders. They do not have the obligation to do that even if the company made a profit that year!

The general threats for to shareholders investment is that a company can go bust or bankrupt, and in that case investor can loose all o his investments. If the company goes bankrupt, the common stockholders will not receive their money until the creditors and preferred shareholders have received their respective share of the leftover assets. This makes common stock riskier than debt or preferred shares. The upside to common shares is that they usually outperform bonds and preferred shares in the long run.

Study of investing and stock market has revealed that in the long term, common stock, by means of capital growth, yields higher returns than almost every other investment. This higher return comes at a cost, because common stock carries the greatest risk. In case the company goes bankrupt and liquidates, the investor holding common stock shares will not receive money until the creditors, bondholders, and preferred shareholders are paid. When people and me in this blog, talks about stocks, they mean on common stocks.