Textbook
1. Common stock
1.1 Basic characteristics
1.2 Rights of common stockholders
1.2.1 Pro-rata share of dividends
1.2.2 Board of Directors
1.2.3 Inspection of books and records
1.2.4 Maintaining proportionate ownership
1.2.5 Stock splits
1.2.6 Assets upon liquidation
1.2.7 Transfer ownership
1.3 Trading
1.4 Suitability
1.5 Fundamental analysis
2. Preferred stock
3. Debt securities
4. Corporate debt
5. Municipal debt
6. US government debt
7. Investment companies
8. Alternative pooled investments
9. Options
10. Taxes
11. The primary market
12. The secondary market
13. Brokerage accounts
14. Retirement & education plans
15. Rules & ethics
16. Wrapping up
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1.2.1 Pro-rata share of dividends
Achievable SIE
1. Common stock
1.2. Rights of common stockholders

Pro-rata share of dividends

Ownership comes with its perks, and common stockholders have several of them. Stockholders do not have the right to vote for dividends, but do have the right to receive their pro-rata share. Pro-rata relates to the number of shares owned. For example, if a stockholder owns 10% of the outstanding shares, they receive 10% of dividends paid. Only the issuer’s board of directors (BOD) approves dividend payouts. We’ll discuss the BODs in further detail in the next section.

Definitions
Outstanding shares
The number of shares held by the company’s shareholders

Common stocks may pay dividends in three forms:

  • Cash
  • Stock
  • Product

Cash dividends

Companies sell their products and services in return for revenue. Once revenue is received, it goes to offset the costs of business expenses. These include the cost of goods sold, operational expenses, interest on outstanding loans, and taxes. If a company has leftover profits after paying its business costs, it has profits (earnings).

Profits are utilized in one of three ways. Companies can retain the profit (also known as retained earnings), pay the profit to their shareholders in the form of a cash dividend, or do a little of both. Companies attempting to expand significantly (known as growth companies) generally do not pay cash dividends. To grow their business, they’ll need to invest their profits into their business. This could include purchasing new properties, obtaining equipment or vehicles, or hiring new employees, which are standard practices for start-ups and smaller companies.

Larger, well-established companies beyond their initial growth phase are more likely to pay cash dividends to their shareholders. For example, McDonald’s started paying dividends in 1976, nearly ten years after it began to expand its business globally. By 1976, McDonald’s was a global brand making significant earnings and started sharing its profits with its investors.

Cash dividends are paid out on a per share basis (for instance, $1 per share). Companies that pay cash dividends on common stock typically make payments quarterly, although this is not required (for example, some prominent companies pay annual cash dividends).

Stock dividends

A stock dividend is a payment of extra shares to stockholders. Although investors receive more shares of stock, this type of dividend is a wash. Stock dividends are simply a “re-shuffling” of numbers to manipulate a stock price. If a company pays a stock dividend of 25%, each investor will end up with 25% more shares. However, each share will fall proportionally in price. Ultimately, a stock dividend does not increase the overall value of a stock position.

As an analogy, imagine you have an apple pie, which we’ll consider as one unit of pie. If you were to cut that apple pie in half, you technically have two units of pie. While you have more pie units, you don’t have more overall pie. Did you track that? If so, a stock dividend is similar.

Here’s an example of a stock dividend question:

An investor owns 100 shares of stock at $20/share. The investor receives a 25% stock dividend. What changes?

Let’s go through the math. The first step is to find the “stock dividend factor.”

To find the “stock dividend factor”, add the stock dividend percent (in decimal form) to 1.

To find the new number of shares, multiply the original number of shares by the “stock dividend factor.”

To find the price per share adjustment, divide the original price per share by the “stock dividend factor.”

Put it all together and compare the before and after to confirm:

Status Position Overall value
Pre-dividend 100 shares @ $20 $2,000
Post-dividend 125 shares @ $16 $2,000

As you can see, the investor ends with the same overall value they started with ($2,000). Use this comparison to confirm your calculation was correct.

Let’s see if you can navigate a stock dividend scenario successfully on your own.

An investor owns 300 shares of JPM stock @ $115. They receive a 15% stock dividend. What changes?

(spoiler)

Step 1: stock dividend factor

Step 2: shares adjustment

Step 3: price adjustment

Step 4: confirm that the overall value is the same

Status Position Overall value
Pre-dividend 300 shares @ $115 $34,500
Post-dividend 345 shares @ $100 $34,500
Sidenote
Cash or stock dividend?

You will likely encounter test questions involving dividends on the exam. Questions may not specifically state what type of dividend is issued, but you can determine whether a cash or stock dividend is being paid based on the information provided.

Cash dividends are stated in terms of dollars per share. For example, a stock pays a $2 per share dividend.

Stock dividends are stated in terms of percentages. For example, a stock pays a 5% dividend.

Product dividends

Companies can make dividend payments from inventory or another company’s stock. For example, Amazon could issue one Kindle per share of stock owned by investors. This type of dividend is not commonly issued, mainly because it’s a taxable event regardless of the investor’s desire for Kindles. How would you feel if you owned 10 shares of Amazon, received 10 Kindles that you didn’t need or want, and got a tax bill for each? Cash and stock go much further, which is why they are much more popular.

Key points

Dividends

  • Can be paid in one of three forms:

    • Cash
    • Stock
    • Product
  • Cash dividends are usually paid quarterly

Stock dividend consequences

  • More shares outstanding
  • Lower price per share
  • Same overall value

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