When you were learning long division in third grade math, you probably first heard the word dividend, a number divided by another number. In the business world, dividend has a similar meaning. In the early 1900s, dividends, pieces of the profits, were paid regularly to shareholders at a fixed dollar per share. It was the main incentive for stock investing. Today, it’s still a motivating factor to purchase dividend-paying stocks.
Who pays dividends?
Dividends are not required; not all publicly corporations pay them. Whether you own stocks individually, or in mutual funds or ETFs, you might receive dividends. All of the companies that are included in the Dow pay dividends. The Dow Jones Industrials (DJI) is a collection of thirty widely held stocks, Blue Chip stocks that are averaged daily and used as a benchmark for the American stock market. Over the years, the corporations included in the Dow have changed, and today the word industrials are a misnomer for what is actually included in the Dow.
Stocks are categorized in many ways, one of which is capitalization, the investment capital that a company has; often referred to as cap. Large cap stocks have over five billion dollars, medium cap stocks have one billion to five billion dollars, small cap have 250 million to one billion dollars, and micro caps have less than 250 million dollars. Many, but not all, large cap corporations pay dividends; smaller companies generally do not.
How are dividends paid?
Though dividends are usually paid in cash from company profits and are earmarked for shareholders, there are actually a few other ways that dividends have been paid historically. In the past, some dividends were paid in company property or assets, such as cocoa beans or railroad cars. This was also known as in kind or scrip, when a substitute for currency was needed such as meals and goods. The concept of scrip has changed much over the years and is very different today. So, if your doctor has prescribed Prozac for you, the good folks at Eli Lilly Pharmaceuticals (LLY) are not likely to pay your dividend in medication; so, don’t even think it.. Special dividends are one time dividends that are paid when a business is sold or liquidated.
When are dividends paid?
It is important for an investor to be knowledgeable of financial terms. With dividends, there are several dates to understand. The declaration date is the date that the company’s Board of Directors announces its intention to pay a dividend. The date of record, or ex dividend date, is the date that shareholders are entitled to dividend. The payment date is when shareholders actually receive a dividend. The declaration date may occur several months before the record or payment date. For example, Hasbro (HAS), one of the few companies that fared well during the troubled economy of the second half of 2008, declared a dividend of $.20 per share as a cash dividend, on December 4, 2008. The record date was February 3, 2009 and the payment date was February 17, 2009. Though most dividends are paid quarterly, some pay yearly such as McDonalds (MCD).
What are the tax implications of dividends?
Look at your 1040 Federal Income Tax form. There’s a line in the income section for dividends; Tax form Schedule B is used to list dividends received from different sources. In 2003, some of the tax laws were revised which positively impacted those who owned dividend-paying stocks. Dividends that were excluded from this changed were those from real estate investment trusts (REITs) and dividends paid to those who owned a mutual fund for less than sixty-one days. When you see ordinary or non-qualifying dividends on your tax form or on the year-end statement 1099 from your fund, they are referring to these excluded dividends, which are taxed at your regular federal income tax rate. But, most dividends, qualified dividends, are taxed at the same rate as long term capital gains, typically 15%.
DRIPs have nothing to do with rainy days!
Dividend reinvestment programs, DRIPs, are easy to set up and may help you owe less income tax. Instead of receiving the cash dividend into your brokerage account, you reinvest it in additional shares. Consequently, you do not pay annual income tax on the dividend. You’re taxed as a capital gain only when you sell the stock, ETF, or mutual fund. A possible downside to DRIPs may be that calculating the cost basis of a stock or fund is more complicated, but your broker can do that for you, so don’t let that deter you.
When stock prices were plummeting last year, shareholders who owned dividend-paying stocks such as General Electric (GE) still received a dividend. That may be the best sales pitch for choosing those companies. Investing in stocks that pay dividends can be a smart strategy for long term investors.