All About Dividends | CFA Level I Equity Investments

As a background for the dividend discount model, let’s take one lesson to first learn everything about dividends. We’ll learn the various ways companies distribute dividends, as well as the chronology of dividend payment.

Types of Dividends

Cash dividends are cash distributions a company makes to its shareholders. Dividends typically refer to cash dividends unless otherwise stated. Dividends for common stockholders are not an obligation but are entirely up to the management’s discretion.

• Regular cash dividends: Typically paid out regularly at known intervals. A long-term record of stable or increasing dividends is widely viewed by investors as a sign of a company’s financial stability.
• Special dividends or extra dividends: Irregular one-off dividends. Many cyclical firms use special dividends to share profits with shareholders when times are good, but maintain the flexibility to conserve cash when profits are poor.
• Stock dividends: Dividends paid in the form of new shares, conserving cash on the firm’s balance sheet. The number of shares increases, but total equity remains the same, so each share is worth less. Stock dividends have no economic impact on the company or shareholders and do not affect the valuation of a company’s common stock as a whole.

Stock Splits and Reverse Stock Splits

Stock splits and reverse stock splits are similar to stock dividends, having no economic effect on the company or shareholders.

• Stock splits: Divide each existing share into multiple shares, creating more shares. For example, a 2-for-1 stock split doubles the total number of outstanding shares, but the price of each share drops correspondingly, leaving the owner’s wealth unchanged.
• Reverse stock splits: Old shares are merged to form fewer new shares, reducing the total number of outstanding shares. The price of each share increases correspondingly, leaving the owner’s wealth unchanged.

Share Repurchases

Share repurchases are an alternative to cash dividend payments. A company uses cash to buy back its own shares, which are then no longer considered for dividends, voting, or computing earnings per share. With fewer outstanding shares, earnings attributable to each share increase, raising the value of each share and shareholder wealth.

Reasons for share repurchases include flexibility in amount and timing of cash distribution, supporting share price when undervalued, tax advantages, and offsetting increases in outstanding shares from employee stock options.

Chronology of Dividend Payment

The payout of regular cash dividends follows a standard chronology:

1. Declaration date: The day the company declares a specific dividend.
2. Ex-dividend date: The first date a share trades without the dividend. If you buy the share on or after this date, you won’t receive the dividend.
3. Holder-of-record date: The date all shareholders listed on the company’s books are recorded for receiving the upcoming dividend.
4. Payment date: The day the company actually sends out or electronically transfers a dividend payment to shareholders.

Lastly, the share price drops by the amount of the dividend paid at the opening of the ex-dividend date. This is because buyers of the shares on this date onwards are no longer eligible to receive the dividend.

With this knowledge on dividends, we’re now better equipped to understand the dividend discount model in future lessons.