Dividends are distributions of earnings to stock holders. Although most commonly in the form of cash or stock, dividends can also consist of property such as merchandise, real estate or investments. Typically companies can only declare dividends out of earnings, although some state laws permit the declaration of dividends from sources other than dividends. Dividends based on sources other than earnings sometimes are described as liquidating dividends because they are return of the stockholders' investment rather than earnings.
Cash dividends are the portion of earnings distributed to stockholders in the form of cash. They become a liability of the company after the board of directors approves or declares their future payment. Cash dividends usually are paid on a quarterly basis shortly after the dividend resolution has been approved by the board. Dividends cannot be paid immediately because the ongoing purchases and sales of the company's stock require that a list of current stockholders be prepared.
Payout Ratio. The payout ratios the ratio of cash dividends to net income. It is the portion of net income or earnings that the company's board of directors pays out in cash. The payout ratio varies widely. Smaller, high growth companies tend to have low pay-out ratios because they have a stronger need to reinvest the cash generated from operations in capital facilities to finance future growth. However many mature, profitable, lower growth companies follow the high payout formula.
Dividend Yield. The dividend yield percentage often is reported in the stock tables of major newspapers. This value is obtained by dividing the annual cash dividend by closing the price of the stock. The annual cash dividend is based on the price of the last regular quarterly payout. If the dividend in the last quarter was $.25 per share, the annual dividend is assumed to be $1.00. This value can be compared with the dividend yield of other stocks with the interest paid on the bonds and other debt instruments.
A stock split is an issuance to stockholders of new shares of stock. For example, a two for one a two for one spilt gives each stockholder two new shares for each share held. A stock dividend is simply a small stock split. For example, if a corporation issues a 5% stock dividend, the owner of 100 shares will receive an additional five shares of stock. Essentially, all that happens with these transactions is that the total number of shares outstanding increases, the price per share decreases proportionately, and the total value of the investors' common stock remains unchanged.
If nothing is to be really gained through stock dividends or stock splits, what is a company's underlying motivation for such actions? For one thing, an unsupported tradition on Wall Street is that a stock price of between $25 to $50 is most appealing to investors. In addition, stockholders seem to react positively to distribution of additional shares even if the total value of their holdings remains unchanged. The price of the stock seems "cheaper" after the spilt than before, especially in a company with a rising earnings trend. Stock splits often occur following run-ups in the price of the stock. Alternatively, companies often issue stock dividends when cash dividends are unaffordable.
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