Question

Describe and contrast the features of common stock and preferred stocks. Explain why dividend payments generally follow changes in earnings. List of important dates for dividend payments and enumerate the advantages of dividend reinvestment plans. What tenet of investing do dividend reinvestment plans subscribe to? What are the similarities and differences between a stock split and a stock dividend? Why would a company do them?

Answer 1

Common stocks and preferred stock are both sources through which capital is raised. The difference lies in their feature as the common stock does have voting right but preferred stock does not have rights. The dividend on preferred stock is paid annual and it can be cumulative or non-cumulative where as the dividend on common stock is not mandatory and if in certain year the company does not have enough earning it can choose not to pay dividends. The dividends on preferred stock are generally fixed whereas the dividend on common stock changes and normally grows at certain rates. The dividend payment generally follows the earning because most companies choose to pay dividends from their earnings, they can not continuously raise funds to pay dividends. There are four Key dates related to dividend, declaration date when the company announces that it will pay dividend, Ex-dividend date is the date when the share price starts to trade without dividend, Record date is the date as on all the shareholders will receive dividend whose name is there, Payment date is the date on which you receive the dividend from the company. The major advantage of dividend reinvestment is that if the company is growing then your future value of investment will increase significantly and your investment corpus will be high. In many countries with dividend reinvestment there is no tax charged on the dividend income and in dividend reinvestment the number of your share holding is increased so capital gain would be high. Dividend reinvesting is similar to average buy method which is used by many investors across the world. When the tax on dividend income is high most investor chooses to reinvest their dividend income in order to reduce the tax liability. Stock split and stock dividend are both corporate events they do not affect the company overall value. In stock split, one share of a company might be split into 2 or 3 shares so the share price comes down and the number of outstanding shares goes up. In stock dividend the company instead of paying dividend pays stock dividend to shareholders so the number of share they hold goes up. Stock split is a way to increase the liquidity for the investor and make the stock accessible to all the investor where as the stock dividend is a way to compensate the shareholder in shares instead of cash dividend.