Types of Cash Dividends
There are three types of cash dividends including regular cash dividends, extra dividends, and liquidating dividends.
- Regular cash dividends are normal cash dividends that are paid by the corporation on a consistent basis. Ideally, regular cash dividends are released four times a year (Stephen, Westerfield, & Jordan, 2012).
- Extra dividends come from extra earnings, which means that they are not regular and are usually dependent on the corporation’s performance within a specified period. These dividends are marked as extra so that the investors realize that they could stop at any time if the company stops getting extra earnings.
- Liquidating dividends are the amounts of money paid out to investors when the corporation is liquidated partially or fully. As a consequence, liquidating dividends are the resultants of selling out some of the company’s stakes or the whole company depending on the situation in question.
The mechanics of a cash dividend payment involve four important dates.
- First, there is the declaration date when the company’s board of directors in question announce the amount of dividends and the date of record.
- The latter is a specified date on which all shareholders would qualify for the dividends (Stephen, Westerfield, & Jordan, 2012). As a result, anyone who held stocks in the company on that specified date would qualify for a dividend payment.
- The date of payment, on the other hand, is a specified date on which dividend checks are mailed to the investors.
- The last important date is the ex-dividend date. This is a date on or past which any stock purchased would not be receiving dividend due to anticipated delays in processing. Further, normal ex-dividend date is often four days before the date of record.
As defined above, ex dividend is a point at which the stock cannot earn a dividend itself. This happens when the stock is bought four or less days before the date of record. When the stock goes ex dividend, its price becomes lower. This is mainly because a stock cannot acquire dividend if it is bought at a time when it cannot already earn it. In this case, the stockholder will be limited in terms of benefiting, and it is only right that s/he buys stocks at a lower price.
Homemade dividends are created when the stockholders opt for creating cash flows by selling their shares rather than waiting for the company’s dividend policy. For example, if a company is paying dividends of about $4.00 and the stockholder has 10 shares, s/he can expect to receive $40. However, if the investors seek for getting more cash, they can sell enough shares to raise the desired amount of cash. In this case, rather than receiving a fixed amount of $40, the investor will have increased his/her dividends at the present pay time. Selling the shares implies forfeiting dividends at a later date, and this implies a reduced amount for the next pay-off. If the investor had to sell 4 shares, s/he can expect to receive other $4.00 for only six shares that s/he has, thus implying a dividend of $24. In the end, instead of $40 and $40 dividend policy, the investor will create a new homemade dividend of $56 and $24. Finally, the investor is likely to get the same amount of money as other investors get for their shares. However, the time at which they get the dividends is altered in favour of the investor.
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Dividends may not be irrelevant but dividend policies are. A dividend is a payment made to stockholders on the earnings of the corporation. Therefore, dividend is a part of the shareholder’s profit in the investment (Stephen, Westerfield, & Jordan, 2022). A dividend can thus not be considered as irrelevant since investors are mainly motivated by profits. Most investors use dividends as a basis of calculating the company’s worth on their portfolio. On the other hand, dividend policies are irrelevant because their total value is always the same regardless of the way dividends are paid out. This means that company can decide to pay out dividends in whichever format and interval, but, in the end, it will be giving its investors the exact value expected.
Low dividends attract lower taxes. Hence, most individuals would prefer the company to retain their dividends rather than pay them out. Low dividends, in this case, are easily retained, and individual investors get to save on taxes. This would not have been possible with a high payout. Low dividends also attract low cost of capital, especially in situations where the dividends are taxed higher than the capital gains. Generally, it can be appreciated that when the dividends are low, the investors are saving on taxes since they can leave the dividends within the corporation.
Based on chapter 17, there are two contexts in which some individual investors can favour high dividend payout (Stephen, Westerfield, & Jordan, 2022). First context appear when the investor is in need of current income. The need for liquid cash or current income often prompts investors to favour high payout on their dividends regardless of the potential benefits of low payout. This is particularly true for cases where the transaction costs are impediments to the effective creation of homemade dividends. The second context is when the shareholders are uncertain about the firm’s future. When a firm has some elements of uncertainty regarding its future, the shareholders could easily favour high payout as a way of resolving their indecision. Here, high payouts are considerably similar to selling the stocks since the shareholders will have forfeited their future claims to the corporation and its dividends.
When one corporation is paying dividends to another, there is some applicable exclusion of taxable income in dividends that the shareholder is receiving. Therefore, non-individual shareholder can prefer high payout without having to worry too much about the applied tax rates. Similarly, when companies prefer high payouts, they do this because they have some taxation privileges meaning they will not be subjected to ridiculously high tax rates on their dividends. Taxes often determine how non-individual investor would prefer to receive payments since one way of maximizing the profits is to seek for tax discounts or exemptions.
The market reaction to an unexpected dividend change is dependent on the kind of change in question. If the dividend has been increased, the price of the stock in the market will also go up. Similarly, an unexpected decrease in dividend volume would decrease the market value of the company’s stocks. Therefore, it is conceivable to assume that a dividend generally signals to the market in terms of the stock value with respect to the company in question. Increasing the dividend could mean that company is on an upward trend in its earnings, while decreasing could imply a troubled descent depending on the situation. This variation of the stock prices with dividends indicates that the latter are very important to the stockholders as well as to the whole market. If the market reacts to changes in dividends, their role in stabilizing the stock prices cannot be ignored.
However, this variation does not say much about the dividend policy. A company could pay its dividends since the value of the stock remains unaffected in the end. If shareholder was to receive $300, s/he would still receive it regardless of the dividend policy used. After all, the dividend policy will not affect the dividends gained by the investor; thus, it will also have no effect on the market price of the company’s shares.
Dividend clientele is a group of investors who are attracted to the company’s different payout policies. This means that the group is basically formed by investors who agree on the specific payout policy. Considering that such clientele is a group of investors with similar interests in the company’s stocks, it can be noted that these investors are likely to shift allegiance if the company no longer meets their needs. If, for example, dividend clientele is chasing high payouts in the company, a decrease in dividends would discourage them from holding stocks within the company. This would then lead them to sell their stocks. The moving stocks, in this case, appear as a result of the clientele effect where a group of investors act in a certain way to follow their own interests.
The effect of clientele can also be seen when a group of investors move in order to create homemade dividends, thus selling or buying a lot of stocks at the same time. The company gets to experience an increase or decrease in stock price depending on whether the clientele is selling or buying its stocks. If they are selling, the stock will decline in price; and if they are buying, it will increase.
From the article, Rolls-Royce (RR) Company is going through a restructuring period in terms of its operations. The organization is not investing in a number of new products, but they are focusing on specified areas of production with a long-term profitability goals (Wall, 2023). Therefore, at the moment, the company’s operational cost is being reduced significantly in terms of streamlining costs. The company is reducing many of its costs in order to accommodate the limited profitability that they are expecting in transition period.
RR has recently invested billions of dollars in developing new engine and some more issues in building the production plants. This means that the majority of the company’s funds have been invested in long-term ventures that could take years to become profitable. In addition, the significance of these investments depends on the company’s ability to get a significant market share in engine industry. Considering that the products are new in the market, the company’s CAPEX is currently in a considerable uncertain state. It could go either way from where it stands. If the engines are received well in the market, the company can expect tremendous returns on their CAPEX. However, if they are not received well, the company will have billions in loss.
The article states that fixed costs at RR are spiralling. This fact is probably owing to the status of the economy and to the company’s needs to remain operational (Wall, 2023). Therefore, despite limited profits, the company continues to operate most of their fixed functions like taxes, salaries, and property rates among other things. The company is shying away from radical changes that may reduce its fixed costs. Other than the planned job cuts, the company is not looking to downsize except for the reduction of expenses in the management section.
RR has taken on a specific market for itself based on the company’s focus on new engines (Wall, 2015). Most of the company’s initial market had outdated technologies, and this has slowly phased out. The market is thus rather dwindling as the clients seek for new technologies. RR has mostly become irrelevant to most of their previous customers owing to their products including the electricity-generating turbines, old aircraft engines being replaced with new, faster and more efficient ones, and a number of other areas where the company has not been able to catch up with. Apart from current new engines, the company’s market is simply disappearing. The competitors seem to have caught up with and are focusing on new technologies already.
The stock price at RR fell significantly before the dividend cut because the company’s clientele seemed interested in high dividends. Moreover, once they noted that they would not be getting high dividends from RR, they opted for selling their stocks and buy stocks from companies that offer higher dividends. Regardless of the circumstances, the investors will always look out for their own interests, and if they are not getting what they want from one company, they will sell their stocks and buy another ones from a company that will give them what they want. This stock market reaction can be explained by the fact that there is large dividend clientele that owned stocks at RR.
Furthermore, by the announcement of an impending dividend cut they lost interest in the company’s stocks. In essence, these investors started selling out their stocks, and this is what caused the decline in RR’s share price in the stock market.