Investing in stocks that distribute dividends can be a winning strategy: but what is a dividend? Here is the definition, calculation and use.
What is a dividend? Knowing the definition, methods of calculation and use, and the meaning of the term is essential for operating on the stock exchange. Literally, the meaning of dividend refers to that portion of corporate profit distributed, upon decision of the shareholders’ meeting, to the shareholders of the same company. By definition, dividends can be distributed in the form of money or other shares.
In the panorama of equity investments, dividends represent a fundamental component for investors who aim to obtain a periodic return on their portfolio. In our guide, we will try to provide a detailed overview of stock dividends, exploring their concrete meaning, the distribution mechanism, the calculation formulas and the payment procedures currently in force.
What are dividends on the stock exchange: meaning and definition
Let’s go back to our definition.
A dividend is the portion of profits that a joint-stock company distributes to its shareholders as compensation for invested capital. This distribution is one of the main motivations for investors to buy shares, since it offers an economic return in addition to any appreciation in the value of the stock.
The decision to pay a dividend is generally made by the board of directors of the company and subsequently approved by the shareholders’ meeting. The amount and frequency of dividends can vary based on the company’s policy and financial performance. Some companies choose to distribute dividends on a regular basis (annually, semi-annually or quarterly), while others may opt to reinvest profits to finance growth, not distributing dividends.
There are different types of dividends:
- ordinary dividends: regular payments made according to the distribution policy established by the company;
- Special dividends: One-off distributions resulting from exceptional profits or special events, such as the sale of a significant asset.;
- Stock dividends: Instead of cash, shareholders receive additional shares in proportion to their holding.
Dividend distributions are influenced by a variety of factors, including the profitability of the company, future investment needs and general economic conditions. It is important to note that not all companies distribute dividends; some prefer to reinvest profits to support growth and expansion.
Once the distribution has taken place, the shareholder will move on to calculating how much money they are entitled to, which is explained later in our article.
Stock dividends, how do they work?
Dividends follow a structured process that involves several stages and key dates.
- Dividend Declaration: The board of directors announces its intention to distribute a dividend, specifying the amount per share, the record date, and the payment date.
- Ex-dividend date: This is the date from which the shares purchased do not give right to the declared dividend. To be eligible for the dividend, an investor must own the shares before this date.
- Record date: This is the date on which the company checks the register of shareholders to determine who is entitled to receive the dividend.
- Payment date: This is the day on which the company makes the dividend payment to registered shareholders.
For example, if a company announces a dividend with an ex-date of April 15, investors must purchase the shares by April 14 to be entitled to the payment. Shares purchased on or after April 15 will not be eligible for the declared dividend.
It is important to note that the share price tends to fall by an amount approximately equal to the dividend paid on the ex-date. This reflects the transfer of value from the company to shareholders in the form of the dividend.
How to calculate the dividend
As previously mentioned, it is the shareholders’ meeting of a company that establishes the amount of the DPS (dividend per share) to be distributed to shareholders. The unit dividend is given by the ratio between the distributed profits and the number of company shares.
Once the DPS has been found, investors who own shares of that company can move on to calculating the "reward" due to them.
There are several steps to take to understand how to calculate the amount of money (or shares) that we are entitled to after the payment of dividends.
- First of all, you need to determine the number of shares owned, a value that can also be obtained simply by contacting your bank, your broker or by checking the report sent to investors on a regular basis. This way, we have the first piece of data in our equation.
- Once you have calculated the exact number of shares owned, you need to know the DPS, that is, the dividend per share that the company has decided to pay to its investors (it is the fundamental element and data of our equation).
- Once you have obtained these numbers, it will be possible to proceed to the calculation of the remuneration due to investors. Indicating with S the number of shares owned, with D the value we are looking for and with DPS the dividend per share decided by the company, to understand how much we are entitled to, we will need to apply the following formula:
| D = DPS x S |
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Let’s take a practical example: as an investor, I own 2,000 shares of company X whose shareholders’ meeting has decided to pay a DPS of 0.50 euros. Applying the formula just highlighted I get:
| D = 0.50 x 2,000 = 1,000 |
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I will be entitled to about 1,000 euros after payment. Here’s how the figure is calculated. Obviously, what has been explained so far is a basic example that does not take into account reinvested dividends.
Who is entitled to it?
One of the most popular questions, in addition to the one relating to the calculation, concerns the beneficiaries of the coupon. In other words: who is entitled to it?
The right to collect the dividend is due to all those shareholders who own even just one share at the opening of the session in which the coupon is detached.
The recognition is due to those who own shares at Monte Titoli S.p.a. on the day preceding the coupon detachment date.
In any case, it is always necessary to remember the two essential dates in this context, which the shareholder must also know.
- Detachment date: is the day on which the shareholder matures the right to receive the dividend;
- Payment date: is the day on which the payment actually takes place.
If the shareholder sells the shares held between the detachment date and the payment date, he still maintains the right to collect; generally, the two dates have about 3 days difference.
The difference between dividend and dividend yield
The dividend yield is the ratio between the dividend paid by a listed company for each individual share and the last market price of the share itself. It is, therefore, an indicator that measures the yield, independently of the share price.
The dividend yield is often seen as a sort of “guarantee”. If it is high, it is rewarded by the market with a rise in prices as it is attractive both to the public of small savers and to mutual fund managers and institutional investors. In reality, it does not take into account the so-called business risk.
Original article published on Money.it Italy. Original title: Cosa sono i dividendi, come funzionano e come si calcolano
