Paying Investors: How Dividends Work

There are two main ways that shareholders can financially benefit from holding stock. The first is through an increase in the value of the stock that they own: as the company's value increases, so does the shareholder's stock value. The second way is through dividend payments, or distributions of a company's profits. Depending on the type of stock, a dividend might or might not be payable. While companies do try to be consistent in the payment of dividends, it's important to understand that investors who purchase common stock in a company are not guaranteed a dividend payment.

Keep in mind that, although the term is commonly used, "LLC shareholder" is a misnomer, as limited liability companies (LLCs) have members rather than shareholders. Unlike corporate shareholders, LLC members are not entitled to receive dividends. Instead, payments from an LLC are known as distributions, and whether distributions are made, and what amount they are when they are made, depends on the terms of the LLC's operating agreement.

Common stock vs. preferred stock

When it comes to dividend payments, investors need to be aware of the differences between common stock and preferred stock, both of which can be issued by corporations. Payment of a dividend depends on a number of factors, including the type of stock you own.

Common stocks are what most people think of when investing in a company. When you own common stock, dividends aren't guaranteed. Instead, whether you receive dividends depends on the corporation's profits and its dividend policy. Preferred stocks, however, guarantee a dividend payout. The frequency of the payout—quarterly, monthly, or annually—varies by company, although quarterly payments are most common.

Unlike preferred stocks, common stocks tend to experience more rapid increases in value when a company is doing well. Additionally, when a company is seeing record profits, owners of common stocks might see a high dividend payment. Preferred stocks, on the other hand, receive only the guaranteed dividend amount, regardless of how well the corporation has done in any particular year.

Dividend policy

A corporation's dividend policy is decided by its board of directors. The decision as to whether dividends should be paid out on common stock, and the amount of any such dividends, depends on a variety of factors.

The main point to remember is that dividends are not paid out if the company has not generated enough profit. However, just because a company decides against paying dividends doesn't mean that it hasn't generated enough profits. It can, instead, opt to reinvest the profits into the company, rather than distribute them among its shareholders.

While reinvesting profits has a number of benefits, such as increasing the potential of future profits, companies generally choose to reinvest profits when faced with rapid growth rates. When growth is slowed, however, the board of directors may decide that paying out dividends might help the company retain its shareholders, while a dividend payment is often a signal to the market that a company is doing well and its continued profitability is expected.

Dividend payment dates

Dividend payment procedures are based on dates relevant to certain company events. If you own shares in a company, and that company announces that dividends will be paid out, the following dates apply:

• Declaration date. This is the date on which the company's board of directors announces that a dividend will be paid.
• Record date. In its dividend announcement, the board also provides a record date. In order to receive the announced dividend, you must be listed on the company's records as being a shareholder on the record date.
• Ex-dividend date. If you bought stock in the company prior to the ex-dividend date, you are entitled to receive the announced dividend. If, however, you purchase stock in the company on or after the ex-dividend date, the dividend payable for the stocks you've purchased is instead payable to the stock seller.
• Payment date. As the name indicates, the payment date is the date on which a dividend is scheduled to be paid.

Holding corporate shares can provide investors with a consistent stream of income. However, whether you receive dividends from the stocks you've purchased depends on a number of factors, and it's important for investors to understand the basics underlying corporate decisions to pay or not pay out dividends. If you need help making decisions about dividends or other corporate matters, consider using an online service provider to guide you through the process.