Cash dividends

Common stock investors may be eligible to receive cash dividends on the shares they own. A dividend is a portion of a company’s earnings that’s distributed to stockholders. Companies are not required to pay dividends, and some companies never do.

Whether a company pays dividends often depends on its business model and stage of growth:

• Smaller, fast-growing companies often don’t pay dividends so they can retain earnings and reinvest in expanding the business.
• Larger, well-established companies often do pay dividends because their businesses are more mature and their profits are already substantial.

Dividends matter to investors because they can provide a return without selling the stock. This can be especially important for investors who want ongoing income (for example, retirees).

Here’s a real-world example using Target in 2021, 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 buy shares of a dividend-paying company and collect dividends over time.

A company’s Board of Directors (BOD) decides whether a dividend will be paid. If the BOD declares a dividend, the company makes a public announcement that typically looks 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 key dates to pull from an announcement like this.

The declaration date is the day the BOD publicly declares the dividend. In this example, the declaration date is January 14th. Only the BOD can declare dividends, and stockholders only have the right to receive a dividend if it’s declared.

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

That settlement rule leads to the ex-dividend date. You typically won’t see the ex-dividend date listed in the dividend announcement, but it’s a critical date. The ex-dividend date (often called the ex-date) is the first day the stock trades without the dividend. If you buy the stock on the ex-date, you do not receive the dividend.

It helps to focus on the word “ex.” You can think of “ex” as meaning “without” (ex-girlfriend, ex-husband, etc.). The ex-dividend date is the “without the dividend” date.

A stock trade must settle on or before the record date for the investor to receive the dividend. Target’s record date was Wednesday, February 17th.

• If an investor buys Target stock on Tuesday, February 16th, they receive the dividend because the trade settles on Wednesday, February 17th (T+1).
• If an investor buys Target stock regular-way on Wednesday, February 17th, the trade settles on Thursday, February 18th. They do not receive the dividend because they are not a settled owner by the record date.

Because Wednesday, February 17th is the first day an investor can buy the stock and not receive the dividend, it is the ex-dividend date.

Conversely, if an investor already owned Target stock and sold it on Wednesday, February 17th, they would keep the dividend. They wouldn’t be removed from the stockholder list (maintained by the transfer agent) until after the record date. Settlement is the key concept behind 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 may see a question involving cash settlement trades, which settle the same day.

Remember: to receive the dividend, you must be a settled owner on the record date.

• If an investor makes a cash settlement trade on the record date, the trade settles the same day, so the investor receives the dividend.
• Therefore, for a cash settlement transaction, the ex-dividend date is the business day after the record date.

The last important date is the payable date, which is when the dividend is actually paid to stockholders. In the Target example, the payable date is March 10th.

Here is an overview of the example above:

Three of these dates are set by the BOD:

• The declaration date (when the dividend is announced)
• The record date (the date you must be a settled owner to receive the dividend)
• The payable date (when the dividend is paid)

The ex-dividend date is based on settlement rules, which are set by the New York Stock Exchange (NYSE) or FINRA.

• The NYSE sets settlement rules for trades executed on the NYSE.
• FINRA sets settlement rules for trades in the OTC market.

Both follow the same settlement timeframes (T+1 for regular way / same day for cash settlement).

Dividend reinvestment plan (DRIP)

A dividend reinvestment plan (DRIP) is created by the actual issuer (TESLA, NVIDIA, XOM, etc ). It automatically reinvests dividends into additional shares instead of paying cash, often with no commission and sometimes at a discounted price. Reinvested dividends are taxable in the year received as ordinary income unless the company gives stock, then it’s taxable when sold.

The exam may ask about the order of the dividend dates. A common memory aid is the acronym “DERP.”

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