June 2: Understanding the Concept of Stocks and Dividends

by David Jenyns on June 2, 2007

Stock and stock trading are words that are thrown about frequently, but not many people know what these terms actually mean.

A share of stock refers to a unit of ownership in a company. If you as an investor own a share of a company’s stock, then you are essentially part owner of that company. With that ownership comes various entitlements. As a shareholder, you have the right to vote-in members of the company’s board of directors. There also may be voting on other important matters to the company. Additionally, you are entitled to proportionate shares of the company’s profits if the company chooses to distribute to their shareholders.

The difference between owning shares of the company and owning a company outright is that the shareholders are protected. This is called limited liability. The shareholders have no liability if the company is prosecuted. For example, if the company you have shares in loses a lawsuit, you are protected. The worst that can happen is that your stocks in the company become worthless. Creditors for the company can’t come after shareholders personal assets. If you owned the business outright, this wouldn’t be true.

There are two types of stock that are used in the stock market. Common stock is the stock that is held by most individuals who choose to invest. Common stock holders have voting rights, and are entitled to share in the dividends that a company receives. Common stocks are the stocks that are being referred two when you hear of a stock being “up” or “down.”

Common stocks have the most liquidity, meaning they are trading daily. This is important because it gives investors the opportunities to buy and sell shares on a daily basis. Many small or little known companies may not trade daily even with common stock, but most, if not all, large companies do offer daily trading.

Preferred stocks, in contrast to common stocks, actually have fewer rights. The difference exists in the payment of dividends. Preferred stock holders have first access to the company’s dividends. Companies that choose to offer preferred stock likely pay dividends consistently. The advantage of buying preferred stock is the regular income from those dividends. To take advantage of the power of preferred stocks, look to invest in companies that make big profits.

These dividends aren’t, however, the bulk of the company’s profits. Smart companies retain some of the profits in acquisitions or to repay business debts. Regardless, profiting from dividends is still one of the best ways to make money with stocks. Although most companies pay dividends by cash, there are some that pay their investors with more stock. Companies that consistently pay large dividends are most likely well established and profitable. The long running history of the company and history of dividend payment is what attracts investors to these stocks. The downside is that the stability does not offer opportunities for growth potential.

Dividends are determined each quarter by the company’s board of directors. If, for some reason, the company is doing poorly financially the board of directors can choose to forego paying the dividend. Keep in mind that they are under no obligation to pay dividends to their investors. Dividends are a choice to be made by each individual company. At the quarterly meeting, if dividends are to be paid, the board of directors also sets the dividend rate. This rate is determined on a per share basis.

Dividends normally have four important dates associated with them. The declaration date refers to the date the board of directors sets the dividend. On this date, the board of directors also announces when the stockholders will get their dividend payment (in the form of a check).

The record date is when the company sets forth the list of shareholders that will be paid a dividend. The investor must own stock before this date in order to be paid a share of the dividends.

The ex-dividend date is perhaps the most important. This day is normally between 2 and 4 days before the record date. The ex-dividend date is established to allow the completion of all transactions. Since it usually takes 3 days to settle a regular stock sale, the ex-dividend day allows those pending transactions to be completed. If you want to receive a dividend, the ex-dividend date is the absolute latest you can invest in the company to receive the dividend.

The payment date is the fourth and final date associated with dividends. This date is when the dividend checks are mailed to all shareholders. The payment date is most often two weeks after the record date.

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