Dividends

Dividends are a share in the profits paid to the shareholders.
The periodic distributions of profit are called dividend payments
Dividends are lump sum payments, paid out every quarter or every six months to the holder of the stock.
The amount of the dividend varies from year to year depending on the profitability of the company
As a general rule companies like to try and keep the level of the dividends about the same each time.
The amount of the dividend is decided by the board of directors and is usually set a month or so before the dividend is actually paid.

Different Types of Dividend

There are two types of dividends a company can issue: cash and stock dividends
Cash Dividend - (an amount per share) usually paid quarterly
Stock Dividend - shareholder receives additional shares - for every 10 shares owned, you get 1) - similar to a stock split (link)
Special Dividend - (unusual) in addition to the regular dividend - can be either cash or stock)
Property Dividend - (unusual) paid with tangible assets the company owns.
Typically only one or the other is issued at a specific period of time (either quarterly, bi-annually or annually) but both may occur simultaneously.
When a dividend is declared and issued, the equity of a company is affected because the distributable equity (retained earnings and/or paid-in capital) is reduced.

Cash Dividend

A cash dividend is straightforward. For each share owned, a certain amount of money is distributed to each shareholder.
Thus, if an investor owns 100 shares and the cash dividend is $0.50 per share, the owner will receive $50 in total.

Stock Dividend

A stock dividend also comes from distributable equity but in the form of stock instead of cash.
A stock dividend of 10%, for example, means that for every 10 shares owned, the shareholder receives an additional share.
If the company has 1,000,000 shares outstanding (common stock), the stock dividend would increase the company's outstanding shares to a total of 1,100,000.
The increase in shares outstanding, however, dilutes the earnings per share, so the stock price would decrease.

Important Dates

1) Declaration Date - the date the dividend payment is announced. Stock price will change
2) Payable Date - the date the dividend is paid to the shareholders
3) Record Date - the date which it Is decided who the shareholders are
4) Ex-Dividend Date - if owned after this date there is no entitlement to the dividend (usually record date - 2)

Ex-Dividend

This means that the upcoming dividend will be payable to the seller of the stock and not the buyer.
The ex-dividend date is the date on which the stock starts to trade ex-dividend. Specific rules are set by the exchanges or market convention. On its ex-dividend date, the price of a stock usually falls by an amount approximately equal to the value of the upcoming dividend.
When a share is bought it either comes with its entitlement to the next dividend (cum) or not (ex).
There is a date at around the time of the dividend payment when the stock goes from cum to ex.
The original holder of the stock will receive the dividend and not the person who is buying the share.

All things being equal when the dividend is paid the share price will fall to offset the disadvantage of not getting the dividend.

The same concepts apply for bond trading, only the words ex-coupon and ex-coupon date apply.

If a company cuts its dividend then its share price would definitley fall
(is the price anticipating the dividend - has it already been factored in ??)

How does the Dividend Affect the Stock Price ?

Dividend up - Share price up
Dividend down or no dividend - share price down

The drop in stock price is in practice more complex.

Tax on Dividends

Dividends are taxed twice, once by the company and then again on the investors tax return.

Dividend Payout Ratio ?
Dividend Cover ?

Scrip Dividends - A common practice in many markets is to offer a choice of cash dividends or more shares (the scrip dividend)
From a firm point of view, it saves cash as it is easier to create new shares than pay dividends. From the investors point of view if dividends are not needed as income, it is a way of getting new shares without paying share tax or brokers commission.
The reaction to a scrip dividend will vary and depend on the tax position. In the UK shareholders who are non tax payers can reclaim the tax paid on dividends.

Cover - Looking at the dividend paid we may want to see how comfortable the firm was when paying the dividend out of profit.
Was all the profit used ?
How much profit was retained for growth ?
For this reason we can compare the profit per share with the net dividend per share
Cover = profit per share / net dividend

If the profit is small but the firm feels it must maintain the dividend, the net dividend is uncovered (uncovered dividend)
Clearly it is being financed out of the reserves and the firms capital is being weakened.

At a time of recession, there is fierce argument about the extent to which firms should try to maintain dividends even if they are not justified by profits.
Pension funds or insurance companies who need income to meet commitments are concerned when dividends are cut or not paid.
Trustees of some investment funds will not allow investment in any company which has passed a dividend in a given previous time period.

Dividend Yield

An indication of how much company pays out in dividends per year relative to share price
annual dividends per share / price per share
or
total annual dividend / market cap

Important

The appreciation of a stocks value is referred to as a capital gain and decline is a capital loss.
At the same time, however, when a growth stock starts to issue dividends, the company may be changing: if it was a rapidly growing company, a newly declared dividend may indicate that the company has reached a stable level of growth that it is sustainable into the future.