What are Homemade Dividends?

//What are Homemade Dividends?
What are Homemade Dividends? 2017-10-04T23:04:22+00:00

Definition: A homemade dividend is the amount of dividend per share that individual investors determine to match their own cash-flow objectives. The homemade dividend is generated from the sale of a percentage of shares owned by an investor.

What Does Homemade Dividends Mean?

What is the definition of homemade dividends? The home made dividend theory is completely different that the dividend policy that a firm applies. If a firm has accumulated cash flows, it will return the value to shareholders in the form of a dividend, or it will repurchase its shares. In both cases, investors seek to maximize their stream of income.

If the firm’s dividend policy does not create significant cash flows for the investor, he is reinvesting the amount in the firm’s stock or he sells off a portion of the stocks he owns to generate the cash flow he needs. In fact, the homemade dividend theory suggests that investors are indifferent to the firm’s dividend policy because by selling off a part of their shares, they can generate the required stream of income.

Let’s look at an example.

Example

On March 6, Bethany owns 100 shares of a construction company, and she gets a dividend of $0.60 per share. However, Bethany was to get $1.00 per share. Can she use a homemade dividend? The answer is yes. But first, she has to wait for the ex-dividend date, which is on March 13. Any stock sold on March 13 or after will distribute its dividends to the seller of the stock.

On March 6, Bethany has $0.60 x 100 = $60. On March 14, one day after the ex-dividend date, Bethany sells 40 of her shares. Although she has 60 shares of the construction company, she still receives $60 because she sold the shares after the ex-dividend date. However, the amount of $60 is now distributed over the 60 shares she has.

On March 14, Bethany gets $60 / 60 = $1.00 dividend per share. So, with a homemade dividend, Bethany increased her dividend per share from $0.60 to $1.00.

Summary Definition

Define Homemade Dividends: Home made dividends are income that is generated when a shareholder sells only a portion of his shares.