You may be familiar with dividends but did you know there is more than one type of dividend? There are four main types of dividend that companies can pay out to shareholders. In this post we will explain what dividends are and the different types of dividend available.
What Is A Dividend?
Before we explore the different types of dividend available, let’s first take look at what a dividend actually is. A dividend is a reward payment made to shareholders from a company’s earnings. Not all companies pay a dividend. Those that do pay dividends may distribute them on a monthly, annual, bi-annual or quarterly basis.
Companies sometimes pay a special dividend which are one off payments made in addition to any ordinary dividends. This is usually when a company has excess cash from an extremely profitable period or profits made from a disposal.
No dividend is fully guaranteed as it is dependent upon the financial health of the company. Dividends can be increased, decreased or cut completely. There are also several different types of dividend we will explain below.
Just as companies can pay different types of dividend, companies can also have different classes of shares. Each share class offers different rights including their entitlements to dividends. The two most common classes of shares are common shares and preferred stock.
Common shares are the type that most people invest in and usually carry voting rights. Although there are a few exceptions as some companies can have two classes of common stock. These are sometimes also referred to as ordinary or equity shares depending on which country you reside. Shareholders of common shares are entitled to a proportion of any distributed dividend.
Preferred stock is different in that it is a form of fixed income security that pays out either a fixed or variable dividend. This ensures the investor a regular income. Read this post to understand more about shares and how they work.
There are different ways that a company can distribute a dividend. These are; cash dividend, stock dividend, property dividend and liquidating dividend. We’ll look at each of these different types of dividends in more detail below.
Different Types Of Dividend Explained
A cash dividend is the most common type of dividend and is paid from a company’s cash earnings. As it is paid out in cash, investors have two options. Elect to take it either as an income or re-invest it back into the company by purchasing more shares. Re-investing is a method to get rich slowly from the compounding effect.
Cash dividends are paid per each share of the company you own. For example, you own 100 shares of Company X. An annual dividend is declared of $1 per share, so for each share you own you receive $1. This means you will receive a $100 total dividend payment. Being 100 shares held x $1 per share dividend = $100.
Dividend yield is the percentage amount of dividends paid in relation to the share price. It is a simple calculation to make. Take the annual dividends per share and divide it by the current share price.
For example, with reference to the above dividend payment example of Company X. Let’s assume Company X’s current share price is $10. To find the yield we would make a simple calculation. Take the annual dividend per share ($1) and divide by the current share price ($10).
So 1/10 = 0.1 which can be expressed as a percentage by multiplying by 100.
0.1 x 100 = 10, therefore this gives us a 10% dividend yield.
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A stock dividend is paid to shareholders in the form of new shares rather than cash. It’s sometimes called a scrip dividend. This method can reward shareholders without reducing the company’s cash balance. A disadvantage to this is that issuing more shares can have a dilutive effect on earnings per share.
If we look at our previous example where Company X has a dividend yield of 10%. Let’s assume that the company needs to conserve cash but wants to reward shareholders with an equivalent 10% yield to be distributed in new shares. This means for every 10 shares you hold, you would receive 1 additional share. So if you own 100 shares in the company you would receive an extra 10 shares in total etc.
One of the less common types of dividend is a property dividend, also known as a dividend in kind. It is considered as a non-monetary dividend and can be paid in the form of different assets the company owns. Assets could include items such as property, equipment or investments. It is basically a dividend paid out in any form that is not cash.
Whilst this isn’t a very commonly used type of dividend it can be used as another option when a company wants to reward shareholders but doesn’t have sufficient cash. The property dividend must be recorded by the issuing company at the fair market value of the assets.
Although a property dividend is different to a stock dividend, it is still possible to receive shares as part of a property dividend. For example, if the company owns another business, then shares may be distributed from this other business to shareholders.
Another alternative property dividend could be a company’s inventory is distributed to shareholders. An example of this would be if Apple declared a property dividend. They could distribute an iPhone to each shareholder as payment.
A liquidating dividend is different to other regular types of dividend payments. It is a payment made to shareholders during a company liquidation. Liquidation is when a company ceases business activities and formally closes, it can be either compulsory or voluntary.
Unlike regular dividends that are paid from profits, a liquidating dividend is paid from the entire shareholder’s equity. It is essentially a repayment of a shareholder’s invested capital in the company.
When a company enters liquidation, all of it’s assets are sold to repay all debts to creditors. There is an order of preference for payment with shareholders being last. Payments are made in the following order;
- Secured creditors with a fixed charge. This includes creditors such as banks with a legal right over specific items of property. This can include machinery, vehicles and property.
- Preferential creditors. This includes employees that are owed wages.
- Secured creditors with a floating charge. This is different to a fixed charge. It involves a debt secured against a group of assets that can change in value.
- Unsecured creditors. Lenders without security interests in the debtor such as suppliers and customers.
Different Types Of Dividend Conclusion
We’ve looked at what dividends are and the different types of dividend that a company can distribute to shareholders. So to recap, a dividend is a payment made to shareholders and can be made in a variety of ways.
The most common being a cash dividend that an investor can use as income or re-invest. A popular alternative is a stock dividend which can be issued to current shareholders as new shares to preserve cash.
Less commonly used is a property dividend that is a non-cash distribution and can be paid from any company assets.
The final type is a liquidation dividend which is different in that it is not paid from a company’s profits. It is paid from shareholder equity when a company enters liquidation.
Dividends are a great reward paid to investors for holding a company’s shares and receiving a part of the profits. Find great dividend paying companies by conducting research online and trade commission free stocks with eToro.
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We hope you’ve found this post helpful in discovering the different types of dividend companies can pay. Find more informative investing and finance articles on our blog including;
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