Tricks Of The Trade

In The Center Ring

Hurry, hurry, hurry! Step right up and get your dividends here! After a corporation has earned a profit, it must decide whether it will pay a dividend. Utilities usually distribute a large portion of their earnings. Real estate investment trusts (REITs) distribute almost all their earnings, while growth companies like Microsoft pay no dividend at all. Whether they're paid in cash or shares of stock, dividends are important to investors and to the performance of their portfolios. Most companies that pay cash dividends do so on a quarterly basis, although some pay monthly or semi-annually. Dividend payments often increase as earnings increase, making some companies' stocks more attractive to investors who seek income as opposed to capital gains.

Who gets the dividend? Holders of a stock on the date of record receive the dividend. The stock trades ex-dividend (without a dividend) two days prior to the date of record, and purchasers at this point do not receive it. In other words, if you purchase two days before the record date, that trade will settle one day after the record date and you will not be entitled to the dividend. Stocks that are trading ex-dividend show an "x" next to the volume of transactions in financial newspapers.

Though some investors think otherwise, buying or selling a stock on the ex-dividend day does not necessarily result in a windfall profit or immediate loss. If a stock is selling for $50 per share and declares a 50-cent dividend, the price of the shares is reduced by the amount of the dividend, making the price per share $49.50 on the ex-dividend date. If purchased prior to the ex-date, an investor would pay $50 and receive the dividend. If purchased after the ex-date, the price would be less the dividend payment. Whether you should buy a dividend-paying stock depends on whether you want to receive a dividend or pay a lower price for your shares. If you're buying shares in a taxable account and do so just prior to the ex-date, you'll receive the dividend and have to pay tax on it--like paying tax on your own money. For some investors, it pays to buy after the ex-date. Consult your tax advisor to determine what's best for you.

If you'll be receiving a dividend, it may be a long time coming. The day the dividend is paid, known as the distribution date, may be several weeks after the date of record. Most companies make payments on a consistent basis, though, so their investors can count on a date the dividends will arrive.

Instead of paying investors in cash, some companies choose to distribute profits in shares of stock. Stock dividends don't change the value of an investor's holdings, although some investors incorrectly believe that a stock dividend increases the assets of the underlying firm.

Here's how it works: Company XYZ declares a 10 percent stock dividend. An investor who holds 100 shares at a price of $20 would then own 110 shares with a price of $18.18. The stock price falls because the number of shares has increased. Stock dividends increase a company's ability to grow because the company still has the cash to invest elsewhere.

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This article was originally published in the March 1998 print edition of Entrepreneur with the headline: Tricks Of The Trade.

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