Glossary

Corporations may pay part of their earnings as dividends to you and other shareholders as a return on your investment. These dividends, which are often declared quarterly, are usually in the form of cash, but may be paid as additional shares or scrip.

You may be able to reinvest cash dividends automatically to buy additional shares if the corporation offers a dividend reinvestment program (DRIP).

Dividends are taxable unless you own the investment through a tax-deferred account, such as an employer sponsored retirement plan or individual retirement account. That applies whether you reinvest them or not.

However, dividends on most US and many international stocks are considered qualifying dividends. That means you owe tax at your long-term capital gains rate, provided you have owned the stocks the required length of time.

Dividends on real estate investment trusts (REITs), mutual savings banks, and certain other investments aren't considered qualifying and are taxed at your regular rate.

You can calculate a dividend payout ratio by dividing the dividend a company pays per share by the company's earnings per share. The normal range is 25% to 50% of earnings, though the average is higher in some sectors of the economy than in others.

Some analysts think that an unusually high ratio may indicate that a company is in financial trouble but doesn't want to alarm shareholders by reducing its dividend.

Many publicly held companies allow shareholders to reinvest dividends in company stock or buy additional shares through dividend reinvestment plans, or DRIPs.

Enrolling in a DRIP enables you to build your investment gradually, taking advantage of dollar cost averaging and usually paying only a minimal transaction fee for each purchase.

Many DRIPs will also buy back shares at any time you want to sell, in most cases for a minimal sales charge.

One potential drawback of purchasing through a DRIP is that you accumulate shares at different prices over time, making it more difficult to determine your cost basis -- especially if you want to sell some of but not all your holdings.

If you own dividend-paying stocks, you figure the current dividend yield on your investment by dividing the dividend being paid on each share by the share's current market price.

For example, if a stock whose market price is $35 pays a dividend of 75 cents per share, the dividend yield is 2.14% ($0.75 ÷ $35 = .0214, or 2.14%).

Yields for all dividend-paying stocks are reported regularly in newspaper stock tables and on financial websites.

Dividend yield increases as the price per share drops and drops as the share price increases. But it does not tell you what you're earning based on your original investment or the income you can expect to earn in the future. However, some investors seeking current income or following a particular investment strategy look for high-yielding stocks.

You must own a security by the record date the company sets to be entitled to the dividend it will pay on the payable date.

The period between those dates -- anywhere from a week to a month or more -- during which new investors in the security are not entitled to that dividend is called the ex-dividend period.

On the day the ex-dividend period begins, which is the first trade date that will settle after the record date, the stock is said to go ex-dividend.

Generally, the price of a stock rises in relation to the amount of the anticipated dividend as the ex-dividend date approaches. It drops back on the first day of the ex-dividend period to reflect the amount that is being paid out as dividend.