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What Are Dividends? - Investing in Stocks

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  • 0:05 Dividends
  • 2:35 Common Stock
  • 3:54 Preferred Stock
  • 5:10 Lesson Summary
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Lesson Transcript
Instructor: Ashley Dugger

Ashley is an attorney. She has taught and written various introductory law courses.

Many people are interested in stock investment, and there are a few basic terms investors and business people should understand. This lesson explains dividends, common stock and preferred stock.

Dividends

Corporations have owners. The owners are known as shareholders or stockholders because they each own shares of stock in the corporation. Stock is a type of security that represents ownership in a corporation. A shareholder can own one share of stock or many shares. The stock signifies a claim on a portion of the corporation's profits and assets. When a corporation earns profits, it can keep those earnings and reinvest the money in the corporation in order to promote growth. Many small or new companies reinvest profits.

Otherwise, the corporation can distribute all or some of the profits in dividends. A dividend is a distribution of corporate profits to the corporation's shareholders. Dividends are normally paid on a quarterly basis; however, a distribution will be dependent on profits and must be approved by the corporation's board of directors. Dividends can be paid in the form of cash or a deposit directly into a shareholder's brokerage account. These are known as cash dividends. Dividends can also be distributed by issuing additional shares of stock. These are known as stock dividends.

Note that dividends are usually distributed to shareholders per share. This means that shareholders receive varying amounts depending on the number of shares each owns. Dividends can also be distributed as a dividend yield. These dividends are paid as a percentage of the current market price of the stock.

For example, let's say that Andrew owns 20 shares of stock in ABC, Inc. The ABC board of directors approves a dividend distribution. It will be paid in the form of cash dividends, paid at a rate of $5.00 per share. ABC will therefore issue payment to Andrew in the amount of $100.00. Now let's take a look at the two main types of stock. Stock is most often issued as either common stock or as preferred stock.

Common Stock

Common stock is ordinary, everyday stock. The majority of stock is common stock. Common stock simply represents an ownership in the corporation and a claim to a portion of the corporation's profits. Common stock shareholders typically receive one vote per share at annual meetings. The corporation's board of directors is elected at these meetings. The board of directors represents the shareholders and oversees major corporation decisions. Common stock shareholders may also vote on other corporate issues, like stock splits.

Additionally, common shareholders sometimes have preemptive rights regarding new stock offerings. When a corporation issues new stock, these shareholders may have the first right to purchase new shares. This helps protect a shareholder's proportional ownership of the corporation.

The main advantage to common shareholders is that common stock often yields a higher return than other types of investments. The main disadvantage is that common stock is a risky investment. Also, in a corporate bankruptcy, common shareholders won't receive proceeds until creditors and preferred shareholders are paid.

Preferred Stock

Now let's turn to preferred stock. Preferred stock also represents a shareholder's ownership in a corporation. However, these shareholders are normally assured a fixed dividend distribution throughout the life of the corporation.

The advantage to preferred shareholders is the guarantee of a fixed dividend, but this guarantee is not absolute. The dividend distribution is dependent on the corporation's financial ability to pay dividends at that time. Preferred shareholders are issued dividends before common shareholders. Another advantage to preferred shareholders involves corporate bankruptcy. Preferred shareholders receive proceeds after creditors but before common shareholders.

A disadvantage is that the stock may be called by the corporation. This means that the corporation can purchase preferred stock from shareholders at any time and for any reason, but usually at a price per share that is higher than what the shareholders paid. Also, preferred shareholders don't usually enjoy the same voting rights as common shareholders.

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