Dividends 101 - Dividend Investing Basics
Every month I have a conference call for both new and old subscribers. During these I'm happy to answer the most common questions that have come in via email or regular mail. At the end of the month I choose the questions that seem to be the most relevant and put them in the newsletter for those who are not able to listen to my conference calls.
1. When do I need to buy a stock in order to qualify for its next dividend?
First of all it's important to be aware that while most companies pay their dividends quarterly, a few pay monthly. Occasionally a company will pay a "special dividend" which is a one time event that's not likely to be repeated. The "ex-dividend date" is the most important date in the payment process. Oddly enough it can't be found on many companies' press releases or other announcements. This is the date on which the stockholder becomes legally and technically entitled to the dividend.
The next date of note is called the "declaration date." By voting on this day to pay the dividend, the corporation is obligated to make specified payment to the shareholders. But which shareholders will actually receive the dividend? On the average trading day millions of shares change hands and dividends can't go to both buyers and sellers.
Thus while the declaration date is good news that a dividend of a certain amount will be paid, this brings us to the "record date." Only those who are the legal owners of shares at the opening of business on the record date are entitled to the dividend. Those investors who sell before the record date or buy after the market opens on that day are out of luck. It takes a company about two weeks to go through the process of getting the dividends to its shareholders either through regular checks or electronic transfers. At that point the company has met its "payment date."
To answer your question more succinctly, for processing time usually an investor needs to have held shares at least two business days before the record date to become eligible for the dividend.
2. I want reinvest my dividends without having to go through a lengthy process each time. How do I go about it?
If you're fortunate enough not to need the dividends from your stocks, I have great news. Dividend reinvestment is just as good a way or even better to build wealth and future earning power as capital gains. Many brokerage firms and even individual dividend paying companies make it easy to reinvest through automatic dividend reinvestment plans known as DRIPS. These offer a low cost or free way to let individuals compound their investor's stake.
Participation generally has two requirements. First the investor needs to own shares that are registered in his own name as opposed to the more common practice of "street name" registration in which the shares are actually held in the name of the investor's broker. Secondly the investor needs to let the company know that he wants his dividends reinvested. A telephone call to the company requesting the proper form, filling it out, and sending it back will usually do the trick.
In spite of their merits, DRIPS have two small drawbacks worth mentioning. One is that even though you are reinvesting instead of taking cash, you'll still have to pay taxes. Also all of the tiny purchases that make up a DRIP account can complicate your cost basis should you decide to sell down the road. This means you should never ever throw your DRIP account statements away.
3. I know that Master Limited Partnerships tend to pay out a lot. What exactly is a "Master Limited Partnership"?
Not just any business lends itself to the MLP format. Tax rules limit the types of trade that can be conducted in an MLP to a handful of activities concentrated in natural resources and real estate. Furthermore, the legal documents that establish and govern a Master Limited Partnership require the firm to distribute all or almost all of its cash flow to investors. From the standpoint of income safety, this high payout arrangement lends itself well only to businesses with stable cash flows.
The basic structure of an MLP differs from an ordinary corporation in one key way. There is not one but two classes of equity investors in an MLP. These are limited partners and a general partner (who may only own one or two percent of the firm's equity). The vast majority of the capital comes from those holding the limited partnership units. Even though the general partners hold almost complete control of the MLP's business, the structure of Master Limited Partnerships have many critical advantages for the limited partners, but one is of paramount importance. The documents that form the partnership require the MLP to pay out all its cash flow. Therefore a mere reluctance to pay cash distributions is not the challenge it so often is among traditional dividend paying companies.