What Are Dividends?

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What Are Dividends?

Let me explain dividends directly to you: they are a percentage of a company's earnings that get paid out to shareholders as their portion of the profits. These payments are typically made quarterly, and the board of directors decides the amount based on recent earnings. You might receive them in cash or as additional shares, and when a company announces one, they also set a payment date for when it hits your account.

Key Takeaways

Here's what you need to grasp: a dividend is simply a distribution of earnings to eligible shareholders, with the board determining payments and amounts. Keep in mind that many companies skip dividends altogether, choosing instead to reinvest earnings back into the business for growth.

How Dividends Work

Dividends function as a reward for your investment in a company, drawn from its net profits. Some companies keep paying them even if profits are thin, and a consistent history of dividends can make a stock more appealing to you as an investor. Mutual funds and ETFs often pay dividends too. For stocks, the board approves them, sometimes with shareholder input, while fund managers base them on the fund's net asset value and incoming dividends. Cash is common, but stock dividends happen as well. Remember, a stock's dividend yield is the per-share dividend as a percentage of the share price, like 2.5%.

Who Gets Dividends and How

If you own common stock in a dividend-paying company, you're eligible as long as you hold it before the ex-dividend date, which is the cutoff for dividend assignment during trades. Payments follow a schedule—monthly, quarterly, or annually—and companies might add special one-time dividends. Not all common shareholders get them, but preferred shareholders are guaranteed a set amount.

Dividend-Paying Companies

You’ll find that larger, stable companies with steady profits are the most reliable dividend payers, especially in sectors like basic materials, oil and gas, banking, healthcare, pharmaceuticals, and utilities. Structures like master limited partnerships and real estate investment trusts must distribute specified amounts to shareholders by law. Funds also pay dividends if their objectives include it.

Who Doesn't Pay a Dividend?

Young, rapidly growing companies in tech or biotech often skip regular dividends, as they reinvest all earnings into development, expansion, or operations. Investors like you might overlook this if the stock price is climbing fast. Once dividends start, cutting or stopping them signals trouble to the market, often seen as declining profits and a hit to your income.

Important Dividend Dates

Dividend payments follow a sequence, and these dates matter for eligibility: the announcement date is when management declares it, needing shareholder approval before payout. The ex-dividend date is when eligibility ends—if you buy on or after, you miss it, but owning one business day prior qualifies you. The record date sets who’s officially eligible, and the payment date is when funds hit accounts.

A dividend can shift a stock's price. For instance, if a stock at $60 declares a $2 dividend, the price might rise to $62 on the news. It could trade at $63 just before the ex-date, then drop on the ex-date since new buyers won’t get the dividend.

Why Do Companies Pay Dividends?

Many investors, including you perhaps, buy stocks for dividends over growth potential—think of steady payers like Coca-Cola. Dividends show shareholders their profit share and build trust. A high dividend might signal strong profits, but it could also mean the company lacks new projects for better returns, favoring payouts over growth. Cutting dividends often spells trouble, though sometimes it funds high-return investments for long-term gains.

Fund Dividends

Fund dividends differ from company ones, based on net asset value reflecting portfolio holdings. Don’t mistake regular payments for great performance—a bond fund might pay monthly from interest income, passing it to you. Stock funds distribute from stock earnings or by selling shares for capital gains.

Are Dividends Irrelevant?

Economists like Miller and Modigliani argue dividend policy doesn’t affect stock price or capital costs. You might be indifferent, using dividends to buy shares or selling shares for cash—either way, your total value stays the same. They say you can create your own dividends synthetically, making policy irrelevant. Still, many investors chase dividends as an incentive.

How to Buy Dividend-Paying Investments

You have options like stocks, mutual funds, or ETFs for dividend investments. Use models like dividend discount or Gordon growth to value stocks based on future dividends. Compare via dividend yield, the dividend as a percentage of share price.

How to Measure Dividends

Measure dividends by dividends per share, the dollar amount per share. Total return includes dividends, interest, and price gains. Taxes matter—high-bracket investors might prefer low-tax dividends.

What Is a Dividend in Business?

In business, dividends are profits shared among investors.

Are Dividends Free Money?

Dividends indicate stable cash flow and profits for income, but you buy the stock or fund first, and they’re taxable, so not free.

What Is an Example of a Dividend?

If a board sets a 5% annual dividend on $100 shares, that’s $5 per share, or $1.25 quarterly.

The Bottom Line

Many see dividends as a sign of healthy profits shared with investors like you. Not every company pays them, and not all care, but if you do, research the best ones for your portfolio.

What Are Dividends?

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