Investors looking for stability, and cash flow from an investment, often turn to companies that pay dividends to shareholders. Dividends are payments made to shareholders, typically paid out of a company’s available earnings after all expenses, including taxes, have been paid. Dividends provide income to investors, and are often an indicator of the company’s overall financial health. However, while there are typically no requirements that a company return cash to shareholders via dividend payments, some scenarios obligate distribution of income.
Real Estate Investment Trusts, or REITs, are vehicles that may buy, sell and lease real estate and property as a means to generate income. REITs are required to pay out 90 percent of its net income to shareholders before taxes to maintain this status. Paying out nearly all of the company’s available earnings avoids the REIT seeing its income taxed at the corporate tax rate. Instead, all available income is distributed to shareholders who subsequently pay their own taxes on these cash distributions.
Trusts and Partnerships
Some entities operate exclusively as a trust and have no real internal business operations. Commonly, these trusts own rights to land or property that is laden with natural resources, such as gold, oil or other precious commodities. These trusts exist under an agreement and receive royalties from the actual producers and operators of the land based on the amount of resources extracted from the property. This agreement may also dictate how the royalties received must be treated and are often required to be distributed to the unit holders of the trust.
Some operating companies have established policies that determine and outline the payments of dividends. In most cases, these policies are put forth by the board of directors and require shareholder approval to implement or to change. That is, once an agreement is in place to pay out a certain percentage of the company’s quarterly net income, those payments must be made to shareholders as long as the policy is in effect. In most cases, implementation of such a policy is not required by law, but is suggested by a company’s management to reward its shareholders and make it an attractive investment vehicle.
While a company is never required to succumb to outside pressure to pay dividends, sometimes adopting a dividend policy is in the best interest of shareholders. Some companies become so flush with cash that their account balance may actually exceed the actual market value of the company. In a scenario like this, the company may become vulnerable to an outside company that can perform a hostile takeover of the business, close the doors, clean out the bank balance and still walk out with a profit. Additionally, some companies, which have seen high growth days, often yield to pressure from major investors to start paying dividends to shareholders.
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