Shares and dividends are closely related; shares are evidence of ownership of an enterprise, such as a company or cooperative venture, while dividends are payments made by the enterprise to those who own the shares, or shareholders. Shares can be purchased in a stock market if the company is publicly held; shares in privately-held companies are also sometimes available, but not in any of the public stock markets. Purchasers of shares of privately-held companies may have to meet special requirements established by the company.
There are basically two different types of shares available to investors: common and preferred. Common stock is the type of stock most issued; many companies don’t issue preferred shares at all. Common stock generally carries with it voting rights in the organization, usually on issues of significance to the company and also for members of the board of directors, although different classes of common stock, as defined by the company, may have different voting rights.
Those who hold preferred shares generally don’t have voting rights, but are generally guaranteed a set dividend for the life of the company. When profits are low or non-existent, preferred shareholders’ dividends are paid from the company’s reserves. Common shareholders’ dividends are not guaranteed, and there may be years when common shareholders receive no dividend at all. In very good years, however, it’s possible for common shares to earn greater dividends than preferred shares.
Shareholders shoulder a greater risk than bondholders and other creditors of the company, and also stand to gain more as well, because if the company prospers, shares and dividends both may increase in value. However, if the company doesn’t do well and must be liquidated, common shareholders often lose their entire investments, because all debts of the company are superior to common shares — that is, they must be paid before shareholders. Preferred shareholders generally share the same risk as common shareholders, although if there is money left over after paying bondholders and other creditors, preferred shareholders will be paid first.
When companies calculate their profits, they also decide how to dispose of them. There are a number of areas in which companies can invest their profits, but one major such area is the distribution of profits among shareholders, although most enterprises won’t distribute all profits to shareholders. At its simplest, this is done by the company deciding how much profit is to be distributed as dividends, and then dividing it among all the shares issuing dividend payments to those shareholders.
Historically, stock shares and dividends have been a major source of income for American retirees, whose pension plans and other retirement savings programs must find reliable investments. When they buy stock shares, they generally restrict their purchases to established companies whose shares are listed on one of the major stock exchanges. Individuals who invest in the stock market must pay careful attention to their record keeping when they sell shares because the income derived from shares and dividends is treated differently for tax purposes. Inadvertently commingling them will generally result in a higher tax liability for the taxpayer.