Have you ever wondered why many people decide to invest in dividends?
A dividend is usually an amount of money or stock disbursed to investors out of a company's earnings. Generally speaking, this is a type of profit from a company which you own as an investor. Before discussing stock dividends in detail, we have to mention the three most common types of dividend – cash, stock and extraordinary.
Then you will be able to find out some information about other dividend types as well as payment options and our recommendation.
Cash, Stock and Extraordinary Dividends
Briefly, a cash dividend is normally the amount of money distributed to stockholders out of a company's earnings. This is the most common way of distributing corporate earnings. It provides shareholders with a steady income and an opportunity for a dividend reinvestment plan.
On the other hand, a stock dividend is a payment to investors made in the form of new shares of a business.
Why is This Opportunity Attractive?
To start with, investing in stock dividends is a way of reinvesting back into the business in the first place. If the company's value increases with time, so does your investment. In addition to that, this type of dividend is not taxable if not sold by shareholders. Avoiding broker commissions is another thing to be reckoned with.
What's more, investing back in a company is a market signal showing the good health of a business thus increasing its symbolic value, which can eventually lead to an increase in the corporation's share price.
If the board of directors of a company decides to pay previously held cash back to shareholders, then this is an extraordinary dividend.
Well, this is a type of cash dividends that are taxable. In order to avoid future tax increases, companies distribute this dividend before the increase in order to save some investors' money.
Other Types of Dividends
Even though a cash dividend is the most preferred type, there are a couple more worth mentioning:
- Property Dividends – These are assets of the company offered to investors – they could be a physical property, shares of subsidiaries and other inventory owned by the business.
- Scrip Dividends – This is something like an official promise issued by the company in which you have invested to certify that they owe you money. For instance, a business is short of cash and pays its shareholders in scrip dividends, thus promising on a piece of paper that the company will eventually pay off this debt.
- Liquidating Dividends – If a company is to be liquidated, its shareholders receive a payment from the company as a return to their initial contribution. Unlike other dividends paid out of a company's earnings, this type comes from a business's capital base. The good thing about it is that it is not taxable.
What Can You Do With Your Dividend?
If you are a shareholder of a company you are eligible to have a share of a corporation's profit. Or, you have the right to receive a dividend.
If you are an investor who prefers cash, you have two options. The first one is to have the money disbursed to your bank account. The second one is to reinvest the dividend by purchasing shares in the company paying the dividend. This is the so-called dividend reinvestment plan. The first option generates income, while the second is better in the long run.
On the other hand, you might prefer stock dividends.
Let's imagine company Z has 1 million USD profit for the third quarter. If a shareholder owns 10,000 shares of a company valued at $5 per share, and the company issues a 10% stock dividend, the shareholder will receive 200 new shares of stock as a dividend.
Even though the cash dividend is the most preferred option as well the most common one, stock dividends have their positive sides. First of all, this dividend is not taxable unless the owner of the shares decides to sell them. What's more, this option gives investors a sort of flexibility – you can sell your shares when you receive them and get cash.
If you want, you can keep the shares and invest in your company's future. Most importantly, this is a sign to the market, indicating that the company is sound and profitable. This could eventually lead to an increase in a corporation's share prices.