Need-to-knows about Dividends

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What are dividends? When a listed company makes a profit, its board of directors may distribute a part of the earnings to existing shareholders. The earnings distributed to shareholders are called dividends. Dividends are not mandatory. It's up to the board of directors whether and how much dividends will be paid. Some may choose to reinvest the earnings to aid the growth of the company.

Companies often pay dividends on an annual, quarterly, or monthly basis. However, a company may also pay an interim dividend after reporting extraordinary earnings.

Dividends can be paid in several ways. In extreme cases, a company may use its own products to pay dividends, but we're most likely to see the following two forms.

• Cash dividends: This is the most common form of dividend in the market.
• Stock dividends: Companies may give more shares to shareholders as dividends. Sometimes, they even distribute shares of another company, usually a subsidiary.

Why would a company pay dividends?

There are two main reasons a company might pay dividends.

To give back

Companies give back to the shareholders who have trusted and supported them by paying dividends. This is how they encourage existing shareholders to stay.

To attract investment

A generous and stable dividend payment is proof of the company's profitability. It can attract more investors to invest in the company.

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What are the four dates related to dividends?

It's important to understand that not all shareholders receive dividends. The following four dates are critical in determining which shareholders are eligible for a dividend payment.

• Declaration Date: On this day, the board of directors announces the dividends, the record date, and the payable date. This decides how much will be paid, who is eligible, and when it will be paid.
• Record Date: This is when the company records information of the shareholders for dividends distribution. Investors who hold stocks of the company on this day will receive dividends.
• Ex-dividend Date: This is the trading day before the record date. As U.S. stocks require two trading days for settlement, investors must buy the company's stocks before the ex-dividend date to receive dividends.
• Payable Date: This is the date when dividends are officially paid. It's often 3 weeks away from the record date.

To sum up, only investors who own stocks on the record date are entitled to dividends.

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How do dividends affect stock price?

The stock price would usually rise by roughly the amount of the dividends announced on the declaration date. This is because when a dividend is announced, investors pour in to buy shares before the ex-dividend date to receive dividends.

On the ex-dividend date, buying stocks no longer entitles investors to dividends. The stock price will drop by an amount similar to that of the dividends. It's important to note that some orders entered before the ex-dividend date would be automatically reduced by the value of the dividend payment in compliance with SEC rules. These include open buy limit, sell stop, and sell stop limit orders.

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How does the dividends payment work in a short sale?

Assuming Company ABC announced that it would give out a dividend of $1.5 per share on March 25 and the record date is March 5 (Thursday). On March 3, Jane sold short 100 shares of ABC stock, planning to return the shares one month later. Would Jane receive the dividends?

Stocks sold on March 3 settled two days later on March 5. Therefore, the investor buying shares from Jane would receive dividends. However, Jane is responsible for paying the dividends when she returns the shares.

To sum up, a short sale is an act of borrowing shares from a broker to sell and buy back the shares later to close out the short position. The short seller shall pay the dividend to the borrower when the borrowed stock pays a dividend. If you're still short on the ex-date, you'll have to pay the dividends.