Cash dividends

Common stock investors are eligible for cash dividends from the stock they own. Dividends are earnings that are passed on to stockholders. Companies are not required to pay dividends, and some companies never pay dividends.

A company’s business model determines if they pay dividends. Smaller, growing companies tend to avoid paying dividends, which allows them to retain their earnings and spend money on scaling (growing) the business. Larger, well-established companies often choose to pay dividends as their business and profits are already sizeable.

Dividends are useful to investors because they provide a return on investment without having to sell the investment. They are especially helpful to investors who are retired and need income from their investments. Let’s take a look at a real-world example of Target in 2021, which is a dividend-paying company:

• March 10th - $0.68 per share dividend

• June 10th - $0.68 per share dividend

• September 10th - $0.90 per share dividend

• December 10th - $0.90 per share dividend

An investor owning 1,000 shares of Target stock throughout 2019 received $3,160 in dividends. Investors seeking income can purchase a number of shares in a dividend-paying company and collect those dividends over time.

A company’s Board of Directors (BOD) determines if a dividend will be paid. If a dividend is declared by the BOD, the company makes a public announcement, which sounds something like this:

On January 14, 2021, Target Corporation announced that its Board of Directors declared a quarterly cash dividend of $0.68 per share of common stock. The dividend will be payable on March 10, 2021 to shareholders of record as of February 17, 2021.

There are a few important dates to remember here. First is the declaration date, which is the day the BOD publicly declares the dividend. In this example, the declaration date is January 14th. Remember, only the BOD can declare dividends. Stockholders only have the right to receive dividends if declared.

Next, the record date is the day a stockholder must be “on the books.” The record date for this example is February 17th. An investor must be a settled owner of the stock on the record date in order to receive the dividend. Keep in mind that stock has a one-business-day (T+1) settlement time frame.

This leads us to the ex-dividend date. You will not find it mentioned in dividend announcements, but it is a very important date. The ex-dividend date (sometimes referred to as the ex-date) is the first day the stock trades without the dividend. Meaning, if you bought the stock on the ex-date, you would not receive the dividend.

Try to focus on the word ‘ex.’ You can replace ‘ex’ with the word ‘without.’ Think about where else you see this word: ex-girlfriend, ex-husband, etc. If a person is your ex, you are now without them. The ex-dividend day can be translated to the “without the dividend” day.

A stock trade must settle on or before the record date for the investor to receive the dividend. The record date for Target’s dividend was Wednesday, February 17th. If an investor purchases Target stock on Tuesday, February 16th, they receive the dividend because the trade settles by the record date. Tuesday would be the trade date and the stock would settle on Wednesday, the first business day after the trade.

If an investor purchased Target stock regular-way on Wednesday, February 17th, the trade would not settle until Thursday, February 18th. They would not receive the dividend because they would not be a settled owner on the stockholder list (maintained by the transfer agent) by the record date. Because Wednesday, February 17th is the first day an investor would buy the stock and not receive the dividend, it is the ex-dividend date.

Conversely, if an investor already owned Target stock and sold their position on Wednesday, February 17th, they would keep the dividend because they wouldn’t be removed from the stockholder list until after the record date. As you’ve probably noticed, settlement is the underlying concept for the ex-dividend date.

To summarize what occurs on the ex-dividend date:

• Investors buying the stock do not receive the dividend
• Investors selling the stock keep the dividend

Most of the time, the test will focus on the ex-dividend date with regular-way settlement. However, you might see a question regarding cash settlement trades, which settle the same day. Remember, all that is required to receive the dividend is to be a settled owner on the record date. If an investor does a cash settlement trade on the record date, they’ll settle the same day and receive the dividend. Therefore, the ex-dividend date for a cash settlement transaction is the business day after the record date.

The last important date to mention is the payable date, which is exactly what it sounds like. It’s when the dividend payment is made to the stockholders. For the Target example, the payable date is March 10th.

Three of the dates mentioned are controlled by the BOD. The BOD decides if and when they publicly declare the dividend (the declaration date), the date an investor must be a settled owner to receive the dividend (the record date), and the date they pay the dividend (the payable date).

The ex-dividend date is based on settlement, which is controlled by the New York Stock Exchange (NYSE) or FINRA. The NYSE controls settlement for trades of securities occurring on the NYSE. FINRA controls settlement for trades in the OTC market. Regardless, both the NYSE and FINRA maintain the same settlement timeframes (T+1 for regular way / same day for cash settlement).

The exam may ask about the order of dates, which can be remembered by the acronym ‘DERP.’

Here’s a video summarizing many of the key points above: