252 Chapter 6 Investments
Dividends
The profits earned by a corporation properly belong to its shareholders, the people who
own the corporation. However, since the corporation is a separate legal entity, a shareholder
does not have the right to access the corporation’s funds directly. Each shareholder receives
a portion of the corporation’s profits when they are paid out in the form of dividends. A
corporation’s board of directors will periodically evaluate the business’s performance and
decide how much money should be paid out to its shareholders (this is known as declaring
a dividend.) Corporations normally hold on to at least some of their profits to use in grow-
ing the business for the future, and some corporations don’t pay out any dividends at all.
On the other hand, sometimes a corporation will pay more in dividends than it earns if it
has a significant amount of unused cash on hand. In either case, the dividends paid out by
a corporation are seldom exactly equal to the corporation’s profits.
Dividends are divided up among the shareholders according to the number of shares
each owns.Example 6.1.1 Zarofi re Systems earned $743,000 in the last quarter, and the
company’s management has declared a dividend of $450,000. The company has
1,000,000 shares of stock issued. If you own 200 shares of the company’s stock, how
much will you receive as a dividend?The $450,000 total dividend must be distributed among the shareholders based on the
number of shares each one owns; $450,000/1,000,000 shares works out to $0.45 per
share. Since you own 200 shares, you will receive (200 shares)($0.45 per share) $90.00.Rounding can be an issue with dividend rate calculations. In Example 6.1.1 the dividend
rate came out evenly, but this will not always happen. Since the dividend rate per share
often comes out to be a fairly small amount of money, it is not uncommon to see dividend
rates carried out to a tenth of a cent. For example, a company might pay a dividend of
12.5 cents per share, or $0.125 per share.
Dividend calculations work out the same way with small businesses as with large ones.Example 6.1.2 Jason and Dave’s dry cleaning business is set up as a corporation.
There are 100 shares of stock; Jason owns 51 shares and Dave owns 49. In the last
quarter the business earned $39,750 in profi ts, and the company declared a dividend
of $35,000. How much will Jason and Dave each get?The $35,000 profi t will be distributed based on the number of shares each person owns;
$35,000/100 shares $350 per share. Since Jason owns 51 shares, he will receive (51 shares)
($350 per share) $17,850.Dave will receive (49 shares)($350 per share) $17,150.In this example, Jason and Dave both own nearly the same number of shares, and so they
receive nearly the same amounts in dividends. Financially speaking, they are close to being
equal owners of the business. However, in another important respect they are not equal at
all. Since Jason owns 51% of the shares of the business, whenever any decisions need to
be made his vote will always beat out Dave’s. With respect to control of the business, they
are not equal at all. While Dave is entitled to his nearly equal share of the dividends, the
decision of how much to pay out in dividends is entirely Jason’s.^1
If you compare Example 6.1.1 with 6.1.2, the difference in the dividend payable per share
is striking. Jason and Dave’s dry cleaning business pays a much larger dividend per share than
Zarofire Systems. Directly comparing these numbers can be very misleading though, among
other reasons because the number of shares is largely arbitrary. The dry cleaning business
has only 100 shares. If they wanted to, Jason and Dave could have structured the company
to have 100,000 shares instead, with Jason owning 51,000 and Dave owning 49,000. The(^1) This assumes that the corporation’s bylaws require that votes will be decided by a majority vote. Corporation
bylaws can be set up so that votes require a larger majority (such as a two-thirds majority). Also some corporations
have different classes of shares, where some shares carry more votes than others.