Dividends and splits are two very important concepts that stock investors must understand to be successful. Dividends add to the total return that an investor earns while holding a stock. Splits, although they do not directly affect an investment's performance, can play an important role in an investor's portfolio.
A stock dividend is a payment to shareholders from the company. Stock dividends can take the form of a cash payment or the granting of additional shares. The most common form of dividends is a cash payment. To qualify for a dividend, a shareholder must own the company stock before the ex-dividend date declared by the company. The company's board of directors also decides when to pay a dividend, and the amount of the dividend.
Many companies pay their shareholders dividends on a regular basis. After the every fiscal quarter, the company declares the amount of the dividend and the dividend payment date.
The company is under no obligation to pay a quarterly dividend. The decision to pay a quarterly dividend is made by the company's board of directors. The board can decide to cancel, raise or initiate a quarterly dividend.
A company can also pay a special dividend in addition to, or instead of, a quarterly dividend. A company typically pays a special dividend upon an extraordinary occurrence, such as a merger or acquisition, or when it has a large stockpile of cash.
A stock split happens when a company's board of directors decides to alter the number of shares available to shareholders. Stocks are split to reduce the share price so that shares are more accessible to investors. When a stock is split, existing shareholders receive additional shares of stock, but the price of each share is reduced. The total dollar amount of each shareholder's stake in the company remains unchanged.
For example, if an investor has 100 shares of a $50 stock, his investment totals $5,000. After a 2-for-1 stock split the investor will own 200 shares at worth $25 per share. His total stake in the company remains $5,000.
Reverse Stock Split
A company can also initiate a reverse stock split. After a reverse stock split the amount of shares each investor owns is reduced, but the price of the stock is raised.
Reverse stock splits are typically initiated by companies that are struggling and whose stock price is very low. Many stock exchanges have minimum limits on the value of the stocks that trade on the exchange. A reverse stock split is often used to raise a stock's price above those minimums. Like regular stock splits, reverse stock splits do not affect the total value of each investor's stake in a company.
Effect of a Stock Split on Dividends
When a stock is split, the dividend per share paid to shareholders is also split, but the total amount paid remains the same. Assume a stock pays a quarterly dividend of $1 per share and an investor owns 100 shares. The total dividend to that investor is $100. After a stock split the investor owns 200 shares and the dividend drops to 50 cents per share. The total dividend paid to the shareholder remains at $100.