Dividends are a form of distributing value back to the shareholders of a company. It may be paid in cash or in the form of additional shares of the company (i.e., stock dividends). Stock dividends are often subject to misconceptions. Some investors confuse stock dividends with a stock split, typically after the share price has risen quite significantly. The two events are quite different, even though they are related in various ways. Understanding how they differ will help you understand why stocks pay out money in the first place and how to use this process to your advantage.

What Is a Dividend?

A dividend is a company's decision to distribute a certain number of shares or cash to its shareholders as a part of its annual dividend strategy. It is often paid when companies are doing well and want to reward their shareholders.

Stock dividends are often paid by giving shareholders extra shares in the company. For example, if you owned 100 shares of XYZ Company which decided to pay a 10% stock dividend on all outstanding shares, it would give you ten additional shares for each 100 you owned.

Number of shares of the company increases as a result of a stock dividend (dividend in the form of additional shares). For example, if the company has 10 million outstanding shares and issues 1 million new shares as a stock dividend, it will have 11 million total outstanding shares (10 + 1).

Dividend Key Dates

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The following dates are important in understanding how dividends work:

Ex-Dividend Date: The ex-dividend date is the first day when an investor cannot buy a company's stock and receive the upcoming dividend payment. After this date, if you buy shares, you will not be entitled to the next dividend payment.

Declaration Date: The date when the board of directors declares that a dividend is to be paid to shareholders. This is usually two weeks before the ex-date.

Record Date: The record date is when all shareholders must have held their shares for at least one full day to receive a dividend payment. It is the day when the company checks its list of shareholders to determine who receives a dividend.

Payment Date: The payment date is when companies pay the dividend e.g., send the checks or electronic deposits in case of cash dividend to shareholders who qualify for them based on their holdings' record dates and ex-dividend dates.

Why The Stock Price Drops After Dividends

When the company goes ex-dividend, the share price drops by the dividend amount as a result of the distributed value to shareholders.

Tax Impact

Income from dividends is taxable but it can be taxed at different rates based on whether it is classified as Qualified or Non-Qualified. Qualified dividends get taxed at a lower rate of long-term capital gains tax whereas non-qualified dividends are taxed as ordinary income.

These are some of the things you must keep in mind when it comes to dividends. While you can generate income through dividends you need to know how to receive them properly.