As a company's earnings grow, its investors may benefit from a shareholder yield, which boosts the value of an original investment. For example, a company may issue a cash dividend directly to investors or reinvest dividends that investors would otherwise receive in cash. As a result, you should review and select an investment option based not only on the quantity and probability of the cash flow generated by the investment but also the manner in which a company returns shareholder yield to its investors.
Calculated as a percentage of a stock's share price, dividends are paid to investors in the form of cash or stock. Because dividends may represent a significant cash outlay for a business, a company's dividend policy is important to its long-term viability. To pay dividends, a company forgoes an opportunity to maintain excess cash in retained earnings, which can be used to finance investment in the plant and equipment necessary to exploit business opportunities. As a result, when a company chooses to issue dividends rather than retain earnings, it signals the financial markets that the company has cash flows sufficient to both fund projects and pay a cash or stock dividend or introduce a dividend reinvestment plan.
An increase in earnings does not lead to an immediate increase in cash dividends. Instead, management will seek confirmation that higher earnings can be maintained over future accounting periods before declaring a dividend to avoid setting investor expectations that can't be met. When cash dividends are paid, many companies pay the dividends regularly -- usually each quarter. Such companies might also pay an extra dividend if the companies benefit from particularly strong earnings and cash flow during a particular accounting period.
Instead of issuing dividend checks to investors, a company may offer a dividend reinvestment program, which allows a shareholder to automatically reinvest declared dividends toward the purchase of additional stock. In so doing, the investor consistently increases his holdings in the company without additional cash outlay. The policy is especially advantageous if a stock price falls. In this case, the investor continues to receive the same dividend, which can be used to buy more shares at a lower price. The greater the number of shares held by an investor, the greater the return in terms of dividend income and capital gains at the sale of the stock.
A stock dividend distributes additional shares of stock to existing shareholders. For example, a shareholder might receive an additional share of stock for every five shares owned if a 5 percent stock dividend is approved by a company's board of directors. The stock dividend decreases the value of each outstanding share although the net asset value of the company and individual shareholders' investments remain unchanged. However, the more shares held by an investor, the greater the return in the form of dividends and capital gains.
- "Investments: An Introduction"; Herbert B. Mayo
- "Financial Management"; Skand Chaturvedi
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