Questions Business and Entrepreneurship

How are the dividends on common stock determined?


Tanuja Chaudhuri

Just another dreamer

The dividends that are part of the profits of a company and are usually distributed among the shareholders. This is determined by the executive team and is further approved by the Board of Directors of the concerned company. The dividends being the earnings distributed to the shareholders are based on the profit earned on a quarterly, half-yearly or annual basis.

The dividend thus decided can be paid in cents or dollars per share. For example, an individual has around 25 stocks in the Company Y, and the Board of Directors have approved to pay a dividend of 20 cents per share, then the amount of dividend one would receive amounts to $5. The profits thus decided is primarily expressed as the reduction of the retained earnings account of the company from the balance sheet.

However, this decision must only be taken after looking into specific critical data which determines the financial status of the company responsible. The first factor being a regular source of investments. If the company wants to attract more and more individuals who are willing to invest a substantial amount and are basically striving for a constant source of income and even acknowledges the long-term capital gains, then it is advisable for the company to pay out a dividend in a proper manner.

The investors believe that the companies providing dividend are stable and safe enough for the investment purpose. The regular payout of the profit would even make the investors think that the company can generate sufficient Net Income thus increasing their trust towards the firm. This decision creates a clientele effect meaning that more investors are attracted and are in favor to keep the shares for a longer term to continue receiving the dividend.

This not only benefits the clients or the investors but is even beneficial for the company as this would not be any up and down in the volume of stock, where the stock level stays high and consistent as the investors would be interested in buying the share. This would even help to reduce the risk of liquidation.

The amount of dividend that is to be paid is also an important decision to be made. The payout divided is decided from the quarterly reports of the company as well as the growth of dividend over the time. The investors looking for investing in a company should look for those who are providing the payout of less than 60% of the net income, such companies might be the ones who offer a regular dividend.

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