What Are Dividends?

If you are new to the financial world, all the fancy terminology can be quite confusing and can leave you feeling daunted. Especially if you are a beginner investor and you want to sharpen up your knowledge. There is just so much information out there.

If you’re new to investing or learning about the financial world, an excellent place to start is understanding what are dividends. What do dividends mean for your investment, and what are critical indicators to be looking at? 

In this article, we’ll give you a brief overview of what are dividends. If it leaves you curious and you want to find out more about how to invest in stocks, you can also take a look here.

What Are Stock Dividends?

Dividends are the payments made by a company to owners of their company stock. This payment is made from the company’s earnings and is approved by the board of directors. 

Paying a dividend is a way a company distributes revenue back to its investors and is one of the primary ways investors earn a return from their investments. 

Although payment of dividends is common, not all stocks pay dividends.

How Do Dividends Works?

On a basic level, dividends are paid per share of stock an investor owns. If you own 50 shares in a company and the company pays an annual dividend of $1, you will receive $50 per year. 

Dividends are usually paid in cash, but sometimes companies choose to pay dividends in the form of issuing additional shares. There are also Dividend Reinvestment Programs (DRIPs) that allows shareholders to reinvest their dividends back into the company’s stock but usually at a discount. 

This is just the bare basics, though. Let’s take a look at some more important detail. 

How Often Are Dividends Paid Out?

Most commonly, companies pay out dividends quarterly. There are some companies that pay dividends monthly or semi-annually. Each dividend payment must be approved by the board of directors. After that, the company will announce when the dividend will be paid, the dividend amount, and the ex-dividend date.

The ex-dividend date of a stock is basically the date after the dividend has been paid out or the right to the dividend has vested. This is the date the stock will be traded without the value of its next dividend payment included. 

A dividend is paid to the person who owned the stock the day before the ex-dividend date. The owner of a company’s stock who sells the stock after the ex-dividend date is entitled to the dividend payment. If an investor purchases the dividend after the ex-dividend date, they will not be entitled to this dividend payment. They will have to wait for the next dividend to be declared to be entitled to a dividend payment. 

What is a Dividend Yield?

Dividend yield is a ratio that is often reported on financial websites and brokerage websites. 

To calculate a company’s dividend yield, you divide the annual dividend by the stock price on a specific date. This ratio shows how much a company pays out as a dividend each year, relative to its stock price. 

Using the dividend yield is very useful to give you an accurate comparison between different dividend stocks due to it being expressed as a percentage. A stock with a stock price of $100 that pays an annual dividend of $6 (dividend yield 6%) has the same dividend yield as a company with a stock price of $10 that pays a yearly dividend of $0,6.

A company’s dividend yield will go up in two scenarios:

1. If the stock price decreases while the dividend payout stays consistent, or
2. The company increases its dividend payment.

Most investors are careful to purchase stock with a dividend yield of over 4%. Generally, if the dividend yield is higher than this, it could indicate the dividend payout is unsustainable. Although there might be some exceptions to this guideline. Real Estate Investment Trusts, with a usual dividend yield of 5% or 6%, is a good example of an exception. 

What is a Dividend Payout Ratio?

The dividend payout ratio is another vital ratio to keep in mind when analyzing company stocks. The dividend payout ratio is the portion of the company’s net income allocated as dividend payments each year. 

Generally, investors look for a payout ratio that is under 80%. If a company pays 100% of its income to dividends, there is a good chance the dividend payout won’t be maintained in the long run. So, if you want to see a dividend’s safety, looking at the dividend payout ratio is a good indicator. 

A company’s dividend payout ratio will also be listed on financial websites or online brokerage websites. 

Two Types of Dividends

You will most commonly encounter dividends that are paid from a company’s common stock. But there are two other types of dividends you should be aware of:

1. Special dividends, and
2. Preferred dividends. 

Special Dividends

When a special dividend is paid, it is paid out on all shares of a company’s common stock. The big difference between a special dividend and a regular dividend is the frequency or consistency with which it is paid. A special dividend is precisely that – special. So, you won’t see it that often. 

A company usually pays a special dividend to distribute profits to its investors that have accumulated over a few years. A company will do this if it doesn’t have an immediate or specific need for these profits. 

Preferred Dividends

Unlike regular or special dividends, preferred dividends aren’t issued to owners of a company’s common stock. Preferred dividends are only paid to owners of preferred stock. 

Preferred stock operates quite similarly to a bond. There are usually fixed quarterly payments. If a company is also unable to pay all its dividends, preferred stock owners will also have a preferential claim on their preferred dividends, and these will be paid first. 

What Kind of Companies Pay the Best Dividends?

Generally, well-established companies pay the best dividends. These companies don’t have to keep on reinvesting their profits back into their business. Companies like startups that are in a high growth cycle very rarely pay dividends. These companies need to keep on reinvesting their profits to expand and ensure growth. 

With established companies, you can generally expect the dividends to increase year after year. This is important as it will outpace inflation in the long-run.

Companies like Apple, Target, and Disney are companies that pay dividends. Once a company pays a dividend, investors generally expect these companies to maintain the dividend payment – even when times are tough. Reliable companies have a reputation for growing dividends. 

Conclusion

We hope you now better understand what are dividends. When analyzing a stock, keep the dividend yield and dividend payout ratio in mind. Even if you are a visa holder, you can invest in stocks. So, don’t let a lack of knowledge hold you back!

Frank Gogol

I’m a firm believer that information is the key to financial freedom. On the Stilt Blog, I write about the complex topics — like finance, immigration, and technology — to help immigrants make the most of their lives in the U.S. Our content and brand have been featured in Forbes, TechCrunch, VentureBeat, and more.

See author's posts