Cents and Sensibility Guy Steele

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Dividends, a longtime
favorite, gain new
attention

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Until last year, the topic of stock dividends may not have always enthralled investors. But when the new tax laws were enacted, a lot of people started thinking about dividends. Maybe you should, too.

Thanks to new legislation, dividends are being taxed at a maximum rate of 15 percent (The new rate was effective Jan. 1, 2003, and expires on Dec. 31, 2008.). Previously, dividends were taxed at your individual income tax rate. As a result, companies are issuing more dividends, and some companies that never paid dividends before are now starting to do just that.

Intrinsic value

Of course, some investors have always known about the value of investing in companies that have a history of paying dividends, and that have increased their dividends over time. Typically, these companies are well run, with a strong interest in rewarding their investors. In addition to paying dividends, many of these stocks offer growth potential.

Now that dividends are more tax-friendly, you have even more reason to learn more about them. For starters, dividends can be paid in various forms, but there are two major categories -- cash and stock. Cash dividends are the most popular; they are typically paid to stockholders out of the corporation's current earnings or accumulated profits.

For example, suppose you own 100 shares of the ficticious ABC Inc. Thanks to shrewd management and innovative marketing techniques, ABC has experienced continual growth, and, as a result, the company declares an annual dividend of $4 a share. You will then earn $400 a year, or $100 paid every quarter.

But what if you don't need the income? Depending on where your shares are held, you may be able to automatically reinvest the dividends back into the company, thereby purchasing more shares.

If ABC Inc. wants to pay a dividend, but doesn't have the necessary cash for all its shareholders, it could issue stock dividends. So, if ABC issues a dividend of 0.05 new shares for every existing share, you will receive five shares for every 100 shares that you own. Generally, stock dividends are tax-free, although you may incur taxes if you sell the shares.

Save the date

As an owner of a stock that pays dividends, you will want to become familiar with some key dates:

» Declaration date. On this date, the board of directors announces to shareholders -- and the market as a whole -- that the company will pay a dividend.

» Ex-date, or ex-dividend date. On or after this date, the stock trades without its dividend. If you bought a dividend-paying stock one day before the ex-dividend, you still get the dividend; if you buy on the ex-dividend date, you won't. Alternately, if you want to sell a stock, but still receive a declared dividend, you'll have to sell on or after the ex-dividend date.

» Date of record. On this date, the company looks at its records to identify its shareholders. If you're an investor, you must be listed as a "holder of record" to guarantee the right of a dividend payout.

» Date of payment. The date when the company mails out the dividend to the holder of record. The date of payment is generally a week or more after the date of record.

At first glance, you might think that you can make a nice profit by buying a stock just before the ex-dividend date.

But it's not that simple.

You aren't the only one who knows when the dividend will be paid -- everyone knows about it.

And because the market sees a dividend payout as a giveaway of profits, it will "punish" the company by lowering its stock price by about the same amount of the dividend on the ex-dividend date.

In other words, forget about those instant gains coming from "well-timed" investments. Also, keep in mind that stocks are subject to market risks, including the potential loss of principal invested; furthermore, stocks are not fixed-rate investments and may not even distribute dividends.

Still, don't forget about dividends. When you buy high-quality, dividend-paying stocks, and place them in a well-diversified portfolio, you can help yourself make progress toward your long-term goals.

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See the Columnists section for some past articles.

Guy Steele is a financial planner and head of the Pali Palms office of Edward Jones. Send planning and investing questions to him at 970 N. Kalaheo Ave., Suite C-210, Kailua, Hawaii, 96734, or call 254-0688