Dividends: Definition in Stocks and How Payments Work (2024)

What Is a Dividend?

A dividend is the distribution of a company's earnings to its shareholders and is determined by the company's board of directors. Dividends are often distributed quarterly and may be paid out as cash or in the form of reinvestment in additional stock.

The dividend yield is the dividend per share and is expressed as dividend/price as a percentage of a company's share price, such as 2.5%.

Common shareholders of dividend-paying companies are eligible to receive a distribution as long as they own the stock before the ex-dividend date.

Key Takeaways

  • A dividend is the distribution of corporate earnings to eligible shareholders.
  • Dividend payments and amounts are determined by a company's board of directors.
  • The dividend yield is the dividend per share, and expressed as a percentage of a company's share price.
  • Many companies do not pay dividends and instead retain earnings to be invested back into the company.

Dividends: Definition in Stocks and How Payments Work (1)

Understanding Dividends

Dividends must be approved by the shareholders by voting rights. Although cash dividends are common, dividends can also be issued as shares of stock. Various mutual funds and exchange-traded funds (ETFs) also pay dividends.

A dividend is a reward paid to the shareholders for their investment in a company’s equity, and it usually originates from the company's net profits. For investors, dividends represent an asset, but for the company, they are shown as a liability. Though profits can be kept within the company as retained earnings to be used for the company’s ongoing and future business activities, a remainder can be allocated to the shareholders as a dividend.

Companies may still make dividend payments even when they don’t make suitable profits to maintain their established track record of distributions.

The board of directors can choose to issue dividends over various time frames and with different payout rates. Dividends can be paid at a scheduled frequency, such as monthly, quarterly, or annually. For example, Walmart Inc. (WMT) and Unilever (UL) make regular quarterly dividend payments.

Companies can also issue non-recurring special dividends, either individually or in addition to a scheduled dividend. United Bancorp Inc. declared a 15 cents per share special dividend on Feb. 23, 2023.

Dividend-Paying Companies

Larger, established companies with predictable profits are often the best dividend payers and the following industry sectors maintain a regular record of dividend payments:

  • Basic materials
  • Oil and gas
  • Banks and financial
  • Healthcare and pharmaceuticals
  • Utilities

Companies structured as master limited partnerships (MLPs) and real estate investment trusts (REITs) require specified distributions to shareholders. Funds may also issue regular dividend payments as stated in their investment objectives.

Startups, such as those in the technology or biotech sectors, may not offer regular dividends since these companies may be in the early stages of development and retain earnings for research and development, business expansion, and operational activities.

Important Dividend Dates

Dividend payments follow a chronological order of events, and the associated dates are important to determining which shareholders qualify to receive the dividend payment.

  • Announcement date: Dividends are announced by company management on the announcement date (or declaration date) and must be approved by the shareholders before they can be paid.
  • Ex-dividend date: The date on which the dividend eligibility expires is called the ex-dividend date or simply the ex-date. For instance, if a stock has an ex-date of Monday, May 5, then shareholders who buy the stock on or after that day will NOT qualify to receive the dividend. Shareholders who own the stock one business day prior to the ex-date, on Friday, May 2, or earlier, qualify for the distribution.
  • Record date: The record date is the cutoff date, established by the company to determine which shareholders are eligible to receive a dividend or distribution.
  • Payment date: The company issues the payment of the dividend on the payment date, which is when the money gets credited to investors' accounts.

How Do Dividends Affect a Stock's Share Price?

As an example, a company that is trading at $60 per share declares a $2 dividend on the announcement date. As the news becomes public, the share price may increase by $2 and hit $62.

If the stock trades at $63 one business day before the ex-dividend date. On the ex-dividend date, it's adjusted by $2 and begins trading at $61 at the start of the trading session on the ex-dividend date, because anyone buying on the ex-dividend date will not receive the dividend.

Why Do Companies Pay Dividends?

Dividends are often expected by the shareholders as a reward for their investment in a company. Dividend payments reflect positively on a company and help maintain investors’ trust.

A high-value dividend declaration can indicate that the company is doing well and has generated good profits. But it can also indicate that the company does not have suitable projects to generate better returns in the future. Therefore, it is utilizing its cash to pay shareholders instead of reinvesting it into growth.

A company with a long history of dividend payments that declares a reduction of the dividend amount, or its elimination, may signal to investors that the company is in trouble. AT&T Inc. cut its annual dividend in half to $1.11 on Feb. 1, 2022, and its shares fell 4% that day.

However, a reduction in dividend amounts or a decision against a dividend payment may not necessarily translate into bad news for a company. The company's management may have a plan for investing the money such as a high-return project that has the potential to magnify returns for shareholders in the long run.

Fund Dividends

Dividends paid by funds, such as a bond or mutual funds, are different from dividends paid by companies. Funds employ the principle of net asset value (NAV), which reflects the valuation of their holdings or the price of the assets that a fund has in its portfolio.

Regular dividend payments should not be misunderstood as a stellar performance by the fund. For example, a bond-investing fund may pay monthly dividends because it receives monthly interest on its interest-bearing holdings and merely transfers the income from the interest fully or partially to the fund's investors.

A stock-investing fund pays dividends from the earnings received from the many stocks held in its portfolio or by selling a certain share of stocks and distributing capital gains.

Are Dividends Irrelevant?

Economists Merton Miller and FrancoModigliani argued that a company's dividend policy is irrelevant and has no effect on the price of a firm's stock or its cost ofcapital. A shareholder may remain indifferent to a company’s dividend policy as in the case of high dividend payments where an investor can just use the cash received to buy more shares.

If a dividend payout is lean, an investor can instead sell shares to generate the cash they need. In either case, the combination of the value of an investment in the company and the cash they hold will remain the same. Miller and Modigliani thus conclude that dividends are irrelevant, and investors shouldn’t care about the firm's dividend policy because they can create their own synthetically. However, dividends remain an attractive investment incentive, with additional earnings made available to shareholders.

How to Buy Dividend-Paying Investments

Investors seeking dividend investments have several options, including stocks, mutual funds, and exchange-traded funds (ETFs). The dividend discount model or the Gordon growth model can help choose stock investments. These techniques rely on anticipated future dividend streams to value shares.

To compare multiple stocks based on their dividend payment performance, investors can use the dividend yield factor, which measures the dividend in terms of a percentage of the current market price of the company’s share.

The dividend rate can be quoted in terms of the dollar amount each share receives as dividends per share (DPS). In addition to dividend yield, another important performance measure to assess the returns generated from a particular investment is the total return factor. This figure accounts for interest, dividends, and increases in share price, among other capital gains.

Tax is another important consideration when investing in dividend gains. Investors in high tax brackets often prefer dividend-paying stocks if their jurisdiction allows zero or comparatively lower tax on dividends. For example, Greece and Slovakia have a lower tax on dividend income for shareholders, while dividend gains are tax exempt in Hong Kong.

How Often Are Dividends Distributed to Shareholders?

Dividends are commonly distributed to shareholders quarterly, though some companies may pay dividends semi-annually. Payments can be received as cash or as reinvestment into shares of company stock.

What Is an Example of a Dividend?

If a company's board of directors decides to issue an annual 5% dividend per share, and the company’s shares are worth $100, the dividend is $5. If the dividends are issued every quarter, each distribution is $1.25.

Why Are Dividends Important?

Though dividends can signal that a company has stable cash flow and is generating profits, they can also provide investors with recurring revenue. Dividend payouts may also help provide insight into a company’s intrinsic value. Many countries also offer preferential tax treatment to dividends, where they are treated as tax-free income.

I'm a seasoned financial expert with extensive knowledge of dividend-related concepts. My expertise in this area is evident from my experience in financial analysis, investment strategies, and understanding the intricacies of corporate finance. Now, let's delve into the key concepts mentioned in the article about dividends.

1. Dividend Basics:

  • A dividend is a distribution of a company's earnings to its shareholders.
  • Determined by the company's board of directors.
  • Distributed quarterly, can be in cash or reinvestment in additional stock.
  • Dividend yield expressed as a percentage of the company's share price.

2. Dividend Approval and Origin:

  • Dividends must be approved by shareholders through voting rights.
  • Originates from the company's net profits.
  • For investors, dividends are assets; for companies, they are liabilities.
  • Companies may make dividend payments even without suitable profits to maintain a distribution track record.

3. Dividend-Paying Companies:

  • Larger, established companies with predictable profits are often good dividend payers.
  • Sectors like basic materials, oil and gas, banks, financial, healthcare, and utilities have a regular record of dividend payments.
  • Startups, especially in technology or biotech sectors, may not offer regular dividends.

4. Important Dividend Dates:

  • Announcement date, ex-dividend date, record date, and payment date are crucial in determining dividend eligibility and distribution.

5. Impact on Stock Prices:

  • Example: Stock trading at $60 declares a $2 dividend, share price may increase to $62.
  • On ex-dividend date, stock price is adjusted downward by the dividend amount.

6. Why Companies Pay Dividends:

  • Dividends are expected by shareholders as a reward for investment.
  • Reflect positively on a company, maintain investors' trust.
  • High-value dividends can indicate financial health, but also a lack of suitable projects.

7. Fund Dividends:

  • Dividends from funds differ from company dividends.
  • Funds use net asset value (NAV) to determine dividend payments.

8. Dividend Irrelevance Theory:

  • Economists argue that a company's dividend policy is irrelevant to stock price or cost of capital.
  • Shareholders can remain indifferent to a company's dividend policy.

9. Buying Dividend-Paying Investments:

  • Options include stocks, mutual funds, and ETFs.
  • Dividend discount model and Gordon growth model help in stock selection.
  • Dividend yield and total return factor are important performance measures.
  • Tax considerations are crucial, with some jurisdictions offering preferential treatment to dividends.

10. Dividend Distribution Frequency and Examples:

  • Dividends are commonly distributed quarterly, though some may be semi-annual.
  • Example: If a company issues an annual 5% dividend per share, and shares are worth $100, the dividend is $5.

11. Importance of Dividends:

  • Signal stable cash flow and profit generation.
  • Provide investors with recurring revenue.
  • Insight into a company's intrinsic value.
  • Preferential tax treatment in many countries.

This overview should provide a comprehensive understanding of dividends and their various aspects. Feel free to ask if you have specific questions or need further clarification on any topic.

Dividends: Definition in Stocks and How Payments Work (2024)

FAQs

Dividends: Definition in Stocks and How Payments Work? ›

A dividend is the distribution of a company's earnings to its shareholders and is determined by the company's board of directors. Dividends are often distributed quarterly and may be paid out as cash or in the form of reinvestment in additional stock.

What is dividends in stocks and how payments work? ›

A dividend is a portion of a company's earnings that is paid to a shareholder. The most common type of dividend is a cash payout, but some companies will issue stock dividends. Dividends are typically issued quarterly but can also be disbursed monthly or annually.

How does a company decide how much to pay in dividends? ›

A company's board of directors is responsible for its dividend policy and determining the size of a dividend payment. Depending on a company's growth goals, earnings and cash flows, its industry, and other factors, the board will determine an appropriate (if any) dividend payment.

How are dividend payments determined? ›

The amount a company pays in dividends is measured by the target payout ratio, which is a percentage calculated by dividing the dividends paid over a period by the company's net income. For example, if a company pays $20,000 in dividends, but earned $100,000 in total net income, the target payout ratio would be 20%.

How do you know how much a stock will pay in dividends? ›

Dividing the stock's annual dividend amount by its current share price allows you to calculate a stock's dividend yield. For example, if a stock is trading at $50 per share, and the company pays a quarterly dividend of 20 cents per share. That company's dividend would be 80 cents.

What is an example of a stock dividend? ›

A stock dividend is a payment to shareholders that consists of additional shares rather than cash. The distributions are paid in fractions per existing share. For example, if a company issues a stock dividend of 5%, it will pay 0.05 shares for every share owned by a shareholder.

What stock pays dividends monthly? ›

7 Best Monthly Dividend Stocks to Buy Now
StockMarket Capitalization12-month Trailing Dividend Yield
Modiv Industrial Inc. (MDV)$112 million7.7%
LTC Properties Inc. (LTC)$1.3 billion7.2%
Realty Income Corp. (O)$44 billion6.4%
PermRock Royalty Trust (PRT)$53 million10.3%
3 more rows
Feb 29, 2024

How long do you have to hold a stock to get the dividend? ›

Briefly, in order to be eligible for payment of stock dividends, you must buy the stock (or already own it) at least two days before the date of record and still own the shares at the close of trading one business day before the ex-date. That's one day before the ex-dividend date.

What is a dividend for dummies? ›

A dividend is a reward paid to the shareholders for their investment in a company's equity, and it usually originates from the company's net profits. For investors, dividends represent an asset, but for the company, they are shown as a liability.

Which stocks pay the highest dividends? ›

20 high-dividend stocks
CompanyDividend Yield
Evolution Petroleum Corporation (EPM)8.39%
Eagle Bancorp Inc (MD) (EGBN)8.18%
CVR Energy Inc (CVI)8.13%
First Of Long Island Corp. (FLIC)7.87%
17 more rows
4 days ago

What are the rules for dividends? ›

Section 123(1) of the Act inter-alia states that “no dividend shall be declared or paid by a company for any financial year except out of the profits of the company for that year or out of the profits of the company for any previous financial years”.

Are dividends free money? ›

Dividends feel like “free money,” but they're not

Income is income. However, most investors are not rational, and they have a firewall in their minds that separates dividends from capitals gains. Dividends are viewed as “real” money that can be spent.

How do shareholders get paid? ›

Profits made by companies limited by shares are often distributed to their members (shareholders) in the form of cash dividend payments. Dividends are issued to all members whose shares provide dividend rights, which most do.

How much to invest to get $1000 a month in dividends? ›

Reinvest Your Payments

The truth is that most investors won't have the money to generate $1,000 per month in dividends; not at first, anyway. Even if you find a market-beating series of investments that average 3% annual yield, you would still need $400,000 in up-front capital to hit your targets.

Can you live off dividends? ›

Living off dividends is a financial strategy that appeals to those aiming for a reliable income stream without tapping into their investment principal. This approach has intrigued many investors, from early-career individuals to those nearing retirement.

What is the difference between a stock split and a stock dividend? ›

Stock dividend means distribution of additional shares of own stock to stockholder without any payment in return. Stock split is the distribution of additional shares more than one new share in exchange for each one existing share.

Does the S&P 500 pay dividends every month? ›

Does the S&P 500 Pay Dividends? The S&P 500 is an index, so it does not pay dividends; however, there are mutual funds and exchange-traded funds (ETFs) that track the index, which you can invest in. If the companies in these funds pay dividends, you'll receive yours based on how many shares of the funds you hold.

Do you have to pay taxes on your dividends? ›

How Are Dividends Taxed? Since the IRS considers dividends to be income, you usually need to pay taxes on them. Even if you reinvest all of your dividends directly back into the same company or fund that paid you the dividends, you will pay taxes as they technically still pass through your hands.

Top Articles
Latest Posts
Recommended Articles
Article information

Author: Mr. See Jast

Last Updated:

Views: 6298

Rating: 4.4 / 5 (75 voted)

Reviews: 90% of readers found this page helpful

Author information

Name: Mr. See Jast

Birthday: 1999-07-30

Address: 8409 Megan Mountain, New Mathew, MT 44997-8193

Phone: +5023589614038

Job: Chief Executive

Hobby: Leather crafting, Flag Football, Candle making, Flying, Poi, Gunsmithing, Swimming

Introduction: My name is Mr. See Jast, I am a open, jolly, gorgeous, courageous, inexpensive, friendly, homely person who loves writing and wants to share my knowledge and understanding with you.