The Rewards of Stock Market Investment
Appreciation isn't the only thing that stocks provide. Some, not all, may pay a set amount for each share owned. This payment is called a dividend and reflects the profits earned by the company and shared with its shareholders.
Even if the price of stock never goes up, a dividend-paying company is another way to earn income. You can figure what the dividend yield is by dividing the amount of the annual dividend by the price of the stock. For example, if the annual dividend is $4.00 per share and the current price of the stock is $50, the dividend yield is 8 percent ($4 ∏ $50). An 8 percent yield from a dividend certainly beats a 5 percent yield on the bank CD.
If paid at all, dividends are usually paid quarterly, although they can be paid semi-annually, annually, or just at one time. Dividends are quoted according to their annual amount, or four times the quarterly payment. So, a $4.00 per share dividend means that $1 per share will be paid each quarter.
Dividends are paid to shareholders “of record.” Record shareholders are those who own the shares on that date. It's important to know who the record shareholders are because the stock can change hands by the time the dividend is actually paid out. Investors who buy stock that has gone ex-dividend (without dividend) don't get the shares. Ex-dividend is three trading days after the day the dividend is declared.
Piggybank on It
DRIPs let investors buy additional shares for virtually no added cost. Instead of commissions, there may be a minimal fee. Investors also can add cash up to certain limits to buy shares, paying only the minimal fee instead of commissions.
When you were in school and someone called you a drip, you were insulted. Today, however, DRIPs (dividend reinvestment plans) are great. Under a DRIP, cash dividends paid by companies are automatically used to buy additional shares (or fractions of shares) in the same company. More than 1,000 companies today, including AT&T, Ford Motor Co., Heinz, and Intel, have DRIPs. For some of them, one share of stock is necessary to get started. Brokerage firms also allow for automatic dividend reinvestment for shares held in “street name” (a shorthand way of saving the name of the brokerage firm).
To check on whether a company offers a DRIP, ask your broker or check out Standard & Poor's Directory of Dividend Reinvestment Plans at your local library.
Dividends are reported annually to shareholders (and to the IRS) on Form 1099-DIV. Taxes are paid on dividends even if they're reinvested in additional shares.
Some companies may believe the price of their stock is too high to attract new investors, and they may decide to split the shares. For example, in a two-for-one stock split, an investor receives two shares in place of each one share he owns. If he starts with 100 shares, he'll have 200 after the split. Other examples of stock splits include a three-for-one split (three shares in place of each one) and a three-for-two split (three shares for each two shares owned). My daughter bought 10 shares of Gap with gifts she received for her bat mitzvah. Today, eight years later, she owns 45 shares without having put in another penny.
A split doesn't immediately affect the total value of what an investor owns. The value before the split is spread among the new shares. So, if 100 shares were worth $50 each, or $5,000, the new 200 shares are worth $25 each, for the same $5,000 total value.
As a practical matter, stock splits may result in eventual appreciation in an investor's holdings. The price of stock after a stock split tends to go up, and it takes only half as much of a price rise to boost the value following a two-for-one split.
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Excerpted from The Complete Idiot's Guide to Money-Smart Kids © 1999 by Barbara Weltman. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.
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