What Are Dividends? Definitions, Insights, and How They Work

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A dividend is a payment from a company to a shareholder who has invested in shares of the company. Publicly traded companies that offer dividends usually pay them on a fixed schedule and the amount given out to shareholders is based on the company’s profit and performance.

So, why should you care about dividends? Not only are dividends a basic part of how the stock market works, they are also a great way to earn passive income. They are usually paid on a quarterly basis, so every three months you should expect to see dividend payments from dividend-paying companies you’ve invested in (as long as they’re in the green).

Dividends are also an accepted form of verified income that can help you get loans and achieve other financial goals. There are more caveats and complexities that we’ll go through below. Read on to see if investing in dividend-paying stocks is your next financial move.

How Do Dividends Work?

In short, an investor invests in a dividend-paying company. At the end of each quarter, the company’s board of directors will decide whether or not to issue dividends based on financial performance. From there, eligible shareholders will receive their dividends in the form of cash (or occasionally additional company shares).

See an overview and explanation of the dividend process below:

1. An Investor Invests in a Dividend-Paying Company

Not all publicly traded companies pay out dividends to their shareholders, those who do are called “dividend-paying companies.”

2. Company Determines Dividend

At the end of each quarter, corporations review their financial performance. The Board of Directors may decide to issue dividends even if they didn’t hit profit goals but especially if they performed well. Sometimes companies will decide to issue stocks in the place of cash dividends.

3. Company Declares the Dividend

This is aptly known as the “declaration date.” Companies announce that they will be issuing dividends and how much that dividend will be per share. For example, a company might announce on June 29th (towards the end of the second quarter) that they will be issuing dividends of $0.10 per share. If you own 100 shares you should expect a dividend payment of $10.

4. Company Declares the Record Date (and Ex-Dividend Date)

Along with the dividend amount, companies will state their “record date,” or the date you need to be in the company’s records in order to receive a dividend. They also announce the ex-dividend date and payable date (date that they will be paid). For our example, the declared record date is Wednesday, July 15th.

The ex-dividend date goes hand-in-hand with the record date — it’s the cut-off date to buy shares and be eligible for a dividend. Investor.gov states, “The ex-dividend date for stocks is usually set one business day before the record date.” Per the example record date of Wednesday, July 15th, the ex-dividend date would be Tuesday, July 14th. You must buy shares before the ex-dividend date, otherwise you won’t be eligible for the dividend payment.

5. The Shareholders Receive Dividends: Payable Date

The shareholders receive their dividend payments on the payable date, usually in the form of a dividend check or, in some cases, as additional company shares. Dividend payments you receive can be used however you please — they can be used to help pay off debt and improve your debt-to-income-ratio.

When Are Dividends Paid?

Dividends are usually paid to shareholders quarterly after companies release their financial performance. After the dividend amount to be paid is announced, companies will determine which shareholders are eligible to receive dividends and how many eligible shares they own. Eligibility has everything to do with when the share was purchased.

Stock Dividend Dates

The dividend dates show the process of how companies determine who is eligible for a dividend payment. Company-specific dates can be found on their own platforms and on resources like Nasdaq. To recap our explanation above, these are the important dividend dates:

  • Declaration Date: Company announces a dividend payment
  • Ex-Dividend Date: Cut-off date for dividend eligibility
  • Record Date: Companies take note of eligible shareholders
  • Payable Date: Dividend funds are released to shareholders

Are Dividends Guaranteed From a Dividend-Paying Company?

In short, no. Companies can roll back their dividends and forgo sending them out to common shareholders if they wish (or if they just can’t afford to). However, once a corporation declares the dividend, they are legally required to follow through.

An Exception: Preferred Investors

Companies are also required to pay scheduled dividends to “preferred investors,” who are high-level investors that give up their right to vote on company matters for the guarantee of steady dividend payouts. Even if companies don’t have the money to pay preferred investors when a scheduled dividend payment comes around, the company has to give the preferred investor an IOU and pay them back for it.

Why Do Companies Pay Dividends?

Why are companies just giving their money away? The main reasons that companies pay dividends are to entice and attract investors. The dividend payment amount correlates with your dividend payout, and the basic principle is the more stocks a person owns, the bigger their dividend payouts will be.

Offering impressive dividends can spark interest among serious investors and create more demand for the shares. Dividends are also a sign to investors that the company is doing well financially since they can afford to pay dividends. Some investors might use their dividends to invest back into the company and purchase more shares.

Why Do Some Companies Not Pay Dividends?

There are many factors that play into these decisions at a corporate level. A big reason that some companies don’t offer dividends is because they want to reinvest maximum profits into the business, especially fast-growing companies that are keeping up with growing pains. Well-established companies will also forgo dividends and instead invest in secondary properties, innovations and other projects with the hope of increasing the share price.

Shareholders that own stocks in a company that doesn’t pay dividends still have the benefits of their voting rights (in certain cases) and increased stock value if a company is performing well — companies may also send bonus dividends with high profits.

Dividend Paying Companies

As mentioned above, dividend-paying companies are publicly traded and usually have a well-established track record of success. A huge portion of high-paying dividend stocks are utility-related, like electricity (ex: S&P) and oil (ex: Chevron). See some additional recognizable dividend-paying corporations below:

  • Apple (AAPL)
  • Wells Fargo (WFC)
  • Exxon Mobil (XOM)
  • Microsoft (MSFT)
  • QUALCOMM Inc. (QCOM)
  • Johnson & Johnson (JNJ)

To find additional dividend-paying companies, check out resources like Kiplinger, Morningstar, and MarketWatch.

How to Calculate Annual Dividend Yield

The dividend yield tells investors how much they can expect to make from their dividends. It’s very important to know the dividend yield in order to understand a dividend’s true value. If you decide to invest in the stock of a company because they promise great dividend payments, those dividends need to be compared to the price that you’re paying for the stock.

There is no “ideal yield” since there are other factors at play like the industry sector. Tech companies typically have lower yields (around 1.5 percent) while the utility sector hovers closer to 3.2 percent. That being said, 4–6 percent is quite good — it’s a fairly high yield but it’s also still a safe yield. The most high-paying dividend stocks usually don’t pay more than 10 percent per quarter. If the yield is so high that it seems too good to be true, it might be. Extremely high-paying dividends could mean that the company may not be able to afford to pay them in the future, especially if they take a financial hit.

To calculate your dividend yield, divide the annual dividend per share by the price per share. See two examples below:

Dividend yield: 6% = Dividend per share: $2 / Price per share: $30

Dividend yield: 2% = Dividend per share: $0.50 /  Price per share: $20

Dividend Pros and Cons: Dividend-Paying Stock Factors

Every type of investment has pros and cons and dividends are no exception. Below we’ve laid out some important pros and cons that can help you better understand the risk in reward by building a portfolio around dividend-paying stocks.

Pros

  • Cushion from the market: Dividends are usually considered a constant, as most dividend-paying companies continue to pay them out to investors even if the stock market takes a dip. This is especially true if you’re a preferred investor.
  • Fairly predictable: Unlike traditional investing, you can look at a given company’s track record and the type of company they are and have a good idea of what type of returns you’ll make.
  • More consistent income: Tied to the two points above, the quarterly nature of dividends makes them a fairly consistent source of income. Unlike waiting for stock prices to rise, dividends usually come in four times a year.

Cons

  • Eventual cap on return: Due to the steady nature of dividends, they won’t have the potential to create gains like those that could be made in traditional investing. For example, you would have a huge return today had you invested in Amazon stocks when it first hit the market whereas the return on dividends is fairly similar year-to-year.
  • Deceptive profits: Knowing the dividend yield of a stock is imperative. Just because a company you’re considering investing in offers large dividends doesn’t mean that you’ll earn a lot back from your investment.
  • Potential dividend cuts: Dividends are fairly reliable but not guaranteed. If a company decides their resources would be better utilized on a new project, they may roll back their dividend distribution or cut them significantly.

What Can I Do With My Dividend Payments?

You finally receive your highly anticipated dividend — now what? When you receive your dividend payout, you can do whatever you want with it. You can use it to pay bills, put it in your savings or reinvest it.

  • Cash Them Out: You can use dividends to pay for anything you’d like (bills, mortgage, and recreational activities).
  • Reinvest Them: Reinvesting your returns into more shares can produce a greater return in the long run.

Will My Dividends Be Taxed?

Since dividends are a form of income, your dividend earnings will likely be taxed. The tax rate is dependent upon the type of dividend and how long you’ve owned the stock. If you meet the minimum reporting threshold, you should check with a tax professional to figure out how to best report dividends on your taxes.

Whether your financial resolutions involve saving for early retirement or a dream summer adventure, investing is a great way to help you get closer to achieving your financial goals or improving your credit score. Also remember that just because a company doesn’t offer steady dividends, that doesn’t mean they aren’t worth investing in. Always research a company before investing — because while dividends are a great perk, they don’t necessarily define a company that’s going to deliver a great return on your investment.

Sources: Dividend.com | Energy & Capital | Indiana Housing & Community Development Authority | SureDividend

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