Dividends are a portion of the company profits paid out to its shareholders. When a company earns a profit, there are two ways in which it can utilize the surplus funds. The company can either decide to reinvest the profits in the business (retained earnings), or distribute it to the shareholders. The distribution of cash to the shareholders can also take two forms: one is share repurchase, and the other is dividends.

In most companies, a part of the profits are kept as retained earnings and the remaining is distributed to the shareholders.

Here are a few salient features of dividends.
<ul>
	<li>The dividends are generally paid based on a payout policy of the company.</li>
	<li>The board of directors of the company declare the dividends every year. In some jurisdictions, such as UK, these board actions require the approval of the shareholders. However, in other jurisdictions such as US, such approval may not be required.</li>
	<li>Dividends are generally paid as a fixed amount per share. For example, $1 per share. Therefore, the shareholders will receive the dividends based on their holdings.</li>
	<li>Unlike, the payment of interest and principal of corporate bet, the payment of dividends to common shareholders is not mandatory, as based on the company performance, the company may decide not to pay dividends in a particular year.</li>
	<li> Payment of dividend is not considered an expense, rather is paid to shareholders from the after-tax profits. In some jurisdictions, the dividends may be taxed at the shareholder level. The tax treatment of dividends may also differ from capital gains tax.</li>
	<li>The dividends can be paid in may forms such as cash dividends, extra dividends, stock dividends, stock splits, and reverse stock splits.</li>
</ul>
The payment of dividends is important for financial analysts as they affect the stock prices and the return on investments.

What are Dividends?

A company can pay dividends in many different forms. The most common form of dividend payment is cash dividends. Let’s take a look at the different forms of dividends:

<strong>Cash Dividends:</strong> In its most common form, a company may decide to pay dividends in the form of cash based on a schedule. Cash dividends can be in the form of regular dividends, special dividends, or liquidating dividends. <a href="https://financetrain.com/cash-dividend/">Learn more »</a>

<strong>Stock Dividends:</strong> In this case, the company pays dividends in the form of new stocks, rather than cash. <a href="https://financetrain.com/stock-dividends/">Learn more »</a>

<strong>Stock Splits: </strong>In this case, the company decides to split each share into multiple shares. A 2-for-1 stock split means each old stock is split into 2 new stocks. <a href="https://financetrain.com/stock-splits-and-reverse-stock-splits/">Learn more »</a>

<strong>Reverse Stock Splits: </strong>Reverse stock splits work exactly opposite to stock splits. Instead of splitting shares, multiple shares are combined into fewer shares. For example a 1-for-2 reverse stock split means 1 new share is issued for every two old shares. <a href="https://financetrain.com/stock-splits-and-reverse-stock-splits/">Learn more »</a>

Each of these types of dividend methods has different impact of the shareholder value and the company. These dividends also impact the financial ratios of the firm. We will discuss each of these methods in detail in the following articles.

Types of Dividends

In its most common form, a company may decide to pay dividends in the form of cash based on a schedule.

The frequency of payments for cash dividends varies across countries. For example, in US and Canada, the dividends are usually paid quarterly, in Europe, they are paid semi-annually, while in most Asian countries, it's paid annually.

Cash dividends can be in the form of regular dividends, special dividends, or liquidating dividends.
<ul>
	<li><strong>Regular Dividends:</strong> These are the dividends that the companies’ pay based on a regular schedule (quarterly, semi-annually, or yearly). It is important for companies to maintain a stable record as it is seen as a sign of financial stability. An increase in regular dividends is also seen as a positive sign that directly impacts the share price.</li>
	<li><strong>Special Dividends:</strong> Special dividends are paid either by companies that don’t pay regular dividends or by companies that pay regular dividends in addition to their regular dividends as a one-time dividend. Such dividends are usually paid in special circumstances such as when a company has huge excess cash or makes phenomenal earnings in a particular period. These are also called irregular or extra dividends. Companies in cyclical industries generally adopt this form of dividends. They will pay less regular dividends but will announce special dividends in good times.</li>
	<li><strong>Liquidating Dividends: </strong>When a company goes out of business and liquidates all its assets, it distributes the proceeds from liquidation to the shareholders in the form of liquidating dividends. Even when a company sells a portion of its assets and distributes the proceeds to shareholders, it’s known as liquidating dividends.</li>
</ul>
<h2>Impact of Cash Dividends</h2>
The payment of cash dividends reduces company’s cash, and thus its assets. It also reduces the market value of the shares by the equivalent amount. Therefore, when a company pays cash dividends, the market value of its stock will drop. For example, if the current stock price is $20, and a dividend of $1 is paid, then the stock price immediately after dividend payment will be $19.
<h2>Impact on Financial Ratios</h2>
The decrease in cash and assets will have the following impact on financial ratios:
<ul>
	<li>Liquidity ratios will decrease</li>
	<li>Debt-to-asset ratio will increase</li>
	<li>Debt-to equity ratio will increase</li>
</ul>

Cash Dividend

Stock dividends are the dividends paid in the form of new stock rather than cash. This is also known as the bonus issue of shares. In general, companies pay 2-10% of stock dividends on the total shares outstanding.

When dividends are paid in this form, after the dividend payment there will be more shares outstanding, however, the value of each stock would have reduced. For example, assume that a shareholder has 10 shares of $10 each. The total value of shares is $100. If the company pays 10% stock dividends (1 new stock), the shareholder will now have 11 shares valuing $100. The value of each stock will now be 9.09.

Here are a few important points about stock dividends:
<ul>
	<li>The total number of shares for each shareholder increases.</li>
	<li>The company does not have to spend any extra cash to issue dividends.</li>
	<li>Stock dividends are not taxable, because there is no change in shareholder value.</li>
	<li>Stock dividends don’t change the ownership structure.</li>
	<li>Stock dividends don’t affect the shareholder’s wealth but the price of each stock reduces.</li>
	<li>Stock dividends are very commonly used in China.</li>
	<li>Stock dividends do not affect liquidity or financial leverage ratios because they don’t affect the assets or equity.</li>
</ul>
<strong>Example</strong>

Let’s take a simple example to understand the impact of 10% stock dividends on shareholders.
<table class="mytable">
<tbody>
<tr>
<th scope="colspan"></th>
<th scope="colspan">Before Dividends</th>
<th scope="colspan">After Dividends</th>
</tr>
<tr>
<td valign="top" width="142">Shares Outstanding</td>
<td valign="top" width="142">100,000</td>
<td valign="top" width="142">110,000</td>
</tr>
<tr>
<td valign="top" width="142">Earnings per share</td>
<td valign="top" width="142">$1</td>
<td valign="top" width="142">$1/1.1 = 0.909</td>
</tr>
<tr>
<td valign="top" width="142">Stock price</td>
<td valign="top" width="142">$10</td>
<td valign="top" width="142">$10/1.1 = 9.09</td>
</tr>
<tr>
<td valign="top" width="142">P/E Ratio</td>
<td valign="top" width="142">10</td>
<td valign="top" width="142">10</td>
</tr>
<tr>
<td valign="top" width="142">Shares owned by a shareholder</td>
<td valign="top" width="142">100</td>
<td valign="top" width="142">110</td>
</tr>
<tr>
<td valign="top" width="142">Ownership value</td>
<td valign="top" width="142">100*10 = $1,000</td>
<td valign="top" width="142">110*9.09 = $1,000</td>
</tr>
<tr>
<td valign="top" width="142">Ownership percentage</td>
<td valign="top" width="142">100/100,000 = 0.1%</td>
<td valign="top" width="142">110/110,000 = 0.1%</td>
</tr>
</tbody>
</table>
As you can see, there is no change in ownership value or ownership stake after stock dividends.

Stock Dividends

A stock split refers to a situation where a company decides to split each share into multiple shares. A 3-for-1 stock split means each old stock is split into 3 new stocks. The impact is that the total outstanding shares increase, but the value of each share declines proportionately.

<strong>Important Points</strong>
<ul>
	<li>Similar to stock dividends, stock splits have no impact on the total shareholder value or the shareholders’ wealth.</li>
	<li>Two-for-one and three-for-one are the most commonly used stock splits, although a company may decide any fraction.</li>
	<li>Companies generally go for stock splits in order to keep their stocks in a certain price range ($20 to $80 is preferred).</li>
	<li>Theoretically, the price of the stock will fall proportionately after the stock split. However, the academic research shows that the stock splits have a positive impact on the company and the actual stock price may be more than its theoretical value.</li>
	<li>Stock splits reduce market liquidity of stocks because the stock prices are now low which makes the percentage brokerage high.</li>
</ul>
<strong>Reverse Stock Splits</strong>

Reverse stock splits are exactly the opposite of stock splits. In this case multiple shares are combined into fewer shares. Here also the key motive is to keep the stock prices within the optimal price band of $20 to $80. So, if a company’s stock price is below this level, the company may go for reverse stock split to increase the stock price.

<strong>Impact on Financial Ratios</strong>

Stock splits and reverse stock splits have no impact on liquidity ratios, financial leverage ratios, as there is no change in the company’s assets or equity.

Stock Splits and Reverse Stock Splits

Once a company has decided to pay the dividends, the dividend payment process starts. The dividend payment chronology is quite standardized but may have some variations in different markets.

Here we will look at the common and important dates in the chronology:

<strong>Declaration date: </strong>This is the first date on timeline on which the company officially declares a dividend, be it a regular dividend or any other type of dividend. The company's board authorizes the dividend payment and it is announced. On this date, the company will also announce the record date and the actual payment date for the dividend.

<strong>Ex-dividend date:</strong> Also called the ex-date, it is the date from which the stock starts trading without dividend. So, any investor who purchases the stock on or after the ex-date will do so at the post-dividend price. Any investor who owns the stock before this date will receive the dividends. In most global markets, the ex-dividend date is set two days before the record date. This is done to adjust for the settlement cycle, which is T+3. In markets like Hong Kong Stock Exchange, the ex-date is one day before the record date because they have T+2 settlement cycle.

<strong>Record date: </strong>Also called holder-of-record date, this is the date on which the shareholders with the ownership of the stock are designated to receive the dividend. This date is usually two days after the ex-dividend date. This date is determined by the company and is generally one week to one month after the declaration date.

<strong>Payment date:</strong> This is the date on which the dividend is actually paid out to the shareholders. This date is also decided by the company and can fall on any date including a public holiday. The time between the record date and payment date can vary from a few days to a month or more.

For <a title="Cash Dividend" href="https://financetrain.com/cash-dividend/">cash dividends</a>, most companies will usually have a set schedule for dividend payments.

Dividend Payment Dates

A share repurchase refers to a transaction where a company buys back its own previously issued shares. A share repurchase can be considered an alternative to cash dividends, as the corporate uses its own cash to buy back the shares.

Once the shares have been repurchased, they are referred to as treasury stock or cancelled, and are not eligible for dividends, voting etc. For all practical purposes, the number of outstanding shares is reduced by the number of shares repurchased.

There are various reasons why a company chooses to repurchase its shares:
<ul>
	<li>If the company perceives the shares to be undervalued or wants to support the share price.</li>
	<li>The company wants flexibility in distributing cash to the shareholders.</li>
	<li>To take advantage of tax structure, in markets where capital gains taxes are lower than taxes on cash dividends.</li>
	<li>To reduce/restrict the number of outstanding shares that might have gone up due to stock split or any other reason.</li>
	<li>To avoid a possible takeover attempt by a large shareholder.</li>
</ul>
<strong>Methods of Share Repurchase</strong>

A company can repurchase shares in four different ways:
<ol>
	<li><strong>Buy in the open market: </strong>The most straightforward way is to buy the shares in the open market. In this method, the shares will be purchased directly from the market at the current market price. The board of a company may authorize to buy a number of shares in this manner. This method offers a lot of flexibility as the company may choose to buy shares at a convenient time. This method is also cost effective compared to other methods.</li>
	<li><strong>Repurchase a fixed number of shares at a fixed price:</strong> Under this method, the company will make a fixed price offer to purchase a fixed number of shares at a fixed price. This price will usually be above the prevailing market price. For example, a company may make an offer to buy 1 million shares at $20 per share. If shareholders offer to sell more than this number of shares, the company will buy shares from different shareholders on a pro-rata basis.</li>
	<li><strong>Dutch auction: </strong>This works similar to the fixed price purchase, but instead of specifying a fixed price, the company sets a range of acceptable prices (minimum and maximum). For example, an offer to buy 1 million shares in a price range of $18 to $22. The different shareholders will then quote the price at which they are willing to sell their shares. After receiving all the bids, the company will qualify these bids starting from the minimum price and then moving up until it has qualified 1 million shares. If the price at which these one million shares were qualified is $20, then all these shareholders who bid, 18, 19 and 20, will be paid $20 per share for their shares.</li>
	<li><strong>Repurchase by direct negotiation:</strong> Under this method, the company will negotiate the price of shares with certain large shareholders and buy the shares from them. This price will usually be higher than the current market price. A company may do so in order to keep away any large shareholders gaining representation, or a possible takeover attempt.</li>
</ol>

What is Share Repurchase and Methods of Share Repurchase

Since the company uses its own cash or borrows money to buy back shares, <a title="What is Share Repurchase and Methods of Share Repurchase" href="https://financetrain.com/what-is-share-repurchase-and-methods-of-share-repurchase/">share repurchases</a> impact the financial statements. In general, the assets and shareholders' equity falls, and the leverage increases.

<strong>Impact on Earnings Per Share</strong>

After repurchase, the number of shares outstanding will fall. The changes in earnings will decide whether the EPS will rise or fall. If the company uses its own funds, the earnings will fall. If the company uses borrowed funds, it will incur interest costs, the earnings will reduce equivalent to the after-tax cost of borrowed funds.

An intuitive approach is to compare the earnings yield (EPS/Price per share) with the after-tax yield on own funds or after-tax cost of borrowed funds. If earnings yield is higher, EPS will rise and vice verse after repurchase.

Let's take an example to understand this. Assume that a company's share price at the time of buyback is $100 and its EPS is $7. The company borrows funds to repurchase shares. The after-tax cost of borrowed funds is 10%.

The company's earnings yield before buyback is $7/$100 = 7%.  Since the earnings yield before buyback is lower than the after-tax cost of borrowed funds, the EPS will fall after repurchase.

<strong>Impact on Book Value per Share</strong>

The impact of share repurchase on Book Value per Share will be as follows:
<ul>
	<li>If Market Price per Share is greater than Book Value per Share, Book Value per Share will decrease.</li>
</ul>
<ul>
	<li>If Market Price per Share is less than Book Value per Share, Book Value per Share will increase.</li>
</ul>
This happens because the shares are repurchased at or above the market value, so when the market price is more than the book value, more money is spent to buy shares having less value which erodes the book value for remaining shares.

Impact of Share Repurchases on Financial Ratios

Both the cash dividends and share repurchase of same value have equivalent effect on the wealth of the shareholders. This assumes that all other factors such as the taxation are the same.

Let's take an example to understand this. Assume a company with the following information:

Shares outstanding: 1 million

Market value: $20 per share

Company profits: $5 million

Profits distributed: $1 million

The company has two alternatives:

Pay cash dividends at $1 per share

Repurchase stock equivalent to $1 million

Let's calculate the impact of wealth in both cases.
<h2>Cash Dividends</h2>
<div class="formula1">

After the dividends are paid, the ex-dividend price would be: $20 - $1 = $19 per share

This can also be calculated as follows:

= ((1 million shares * $20 per share) - $1 million dividends)/1 million shares

= $19 per share

So, the shareholder has a stock worth $19 and $1 in cash that he receives in the form of cash.

Total wealth for each share = $19 + $1 = $20

</div>
<h2>Share Repurchase</h2>
<div class="formula1">

For $1 million, the company will purchase 1,000,000/20 = 50,000 shares. The share price after repurchase can be calculated as follows:

= ((1 million shares * $20 per share) - $1 million dividends)/(1 million shares - 50,000 shares)

= $19,000,000/950,000

= $20

Total wealth for each share  = $20

</div>
As you can see, in both cases the shareholder's wealth remains the same. So, practically, cash dividends have the same impact on shareholder's wealth as the share repurchase.

Cash Dividends Vs. Share Repurchase

Dividends and Share Repurchases

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Dividends and Share Repurchases

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