Learn About Dividends and How They Work
Some companies choose to share profits with their shareholders. These profit sharing payments are referred to as dividends. They’re paid on a regular basis and are one of the ways you can get a return on your investment.
A dividend is paid per share of a stock in a specific company. For example, if you own 30 shares in a company and that company pays $2 in annual cash dividends, you’ll earn $60 per year.
Remember, not all stocks pay dividends. So, if you’re interested in investing in dividends, make sure you’re buying stocks in companies that share profits.
Why do companies pay dividends?
A company may choose to pay dividends to its shareholders for a variety of reasons:
- Shareholders view dividends as a reward for their trust in a company
- Dividends help maintain shareholder trust and reflect positively on a company’s growth
- Shareholders prefer dividends because they are treated as tax-free income in many countries
Types of dividends
Dividends are usually paid out on a company’s common stock. A company can choose to pay dividends to its shareholders in several ways.
Cash dividends
These are the most common type of dividend. Companies will usually deposit these dividends directly into a shareholder’s brokerage account.
Stock dividends
Instead of paying cash dividends, a company may choose to pay investors with additional shares of stock.
Dividend reinvestment plans (DRIP)
Investors in dividend reinvestment programs have the option to reinvest any dividends back into the company’s stock, sometimes at a discount.
Special dividends
Special dividends pay out on all shares of a company’s common stock, not just dividend stock. But they usually only pay out once, not quarterly or annually like dividend stocks.
A company will often issue a special dividend payout to share profits they’ve accumulated over several years.
Preferred dividends
A preferred stock works more like a bond and less like a stock. Preferred dividends are usually paid out quarterly and are generally fixed, unlike dividends on common stock.
How often are dividends paid?
In the United States, companies usually pay dividends quarterly, though some pay monthly or semiannually. A company's board of directors must approve each dividend.
The company will then announce when the dividend will be paid, the amount of the dividend, and the ex-dividend date.
What is an ex-dividend date?
The ex-dividend date is a very important date to look at. Investors must own the stock by that date to receive the dividend.
Investors who purchase the stock after the ex-dividend date will not receive the dividend.
Investors who sell the stock after the ex-dividend date are still entitled to receive the dividend, because they owned the shares as of the ex-dividend date.
Why buy dividend stocks?
Stocks that pay dividends can provide a stable and growing income stream. Investors typically prefer to invest in companies that offer dividends that increase year after year, which helps outpace inflation.
Dividends are more likely to be paid by well-established companies that no longer need to reinvest as much money back into their business. High-growth companies rarely pay dividends because they need to reinvest profits into expanding their growth.
Remember, dividends on common stock are not guaranteed. However, once a company establishes or raises a dividend, investors expect it to be maintained, even in tough times.
Because dividends are considered an indication of a company's financial well-being, investors often will devalue a stock if they think the dividend will be reduced, which lowers the share price.
Should I invest in dividends?
Before you start investing in dividends, it's wise to make sure you have a solid monthly budget in place, have an emergency savings fund, and fully understand the risks involved.
Understanding how to invest in the stock market could generate financial gains in the long run. Uninformed investing, however, could cost you.
Take advantage of our free online educational courses to help you better understand investing. And if you're looking for advice on how to improve your finances, don't hesitate to contact us. We're here to help.
