Dividends are payments from corporate earnings to company shareholders, and they're one way to receive a return from owned shares. A simpler definition for dividends is that they’re a reward for investing your money with a company.
How Do Dividends Work?
Dividend payments typically take one of two forms:
Cash paid to you (more common)
Additional stocks issued to you (less common, but you can sell and convert to cash)
Companies may also offer dividend reinvestment programs (DRIPs). These programs allow you to reinvest some (or all) of the dividend back into additional shares of the company at a discounted rate.
Note: Not all stocks pay dividends. To receive paid dividends, you’d need to choose one of the following:
dividend mutual funds (a collection of dividend stocks), or
exchange-traded funds (ETFs) that pay dividends
Who Pays Out Dividends?
The company board of directors determines the dividend amount and manages these payments. The amount is usually a portion of company earnings. Companies can choose to not pay dividends and instead reinvest the money back into the company. Again, this type of action must be approved by the board.
Most cash dividends in the United States are paid on a quarterly basis while stock dividends are generally paid at infrequent intervals.
Important Dividend Dates
Before investing, it’s important to know when a company pays its dividends. You should be familiar with the following terms:
Dividend Declaration Date
The dividend declaration date occurs when a company's board of directors declares that a dividend will be paid. Based on the company’s financial performance, the board determines the amount of the dividend and then declares dividend payments to shareholders on record.
Dividend Record Date
The dividend record day occurs when a company reviews its books to determine its "shareholders on record." Shareholders who hold a particular stock on this date will receive the firm's dividend payment.
The board of directors also announces the dividend record date.
After the record date has been determined, the stock exchanges or the National Association of Securities Dealers (NASD) assign the ex-dividend date. The ex-dividend date lands exactly one trading day before the record date.
This date is crucial to shareholders because it determines whether you are paid or not. If an investor buys a stock before the ex-dividend date, then they will receive the dividend payment. If they purchase the stock on or after the ex-dividend date, they will not receive the dividend.
There are endless examples of dividends, but we’ll focus on cash dividends and stock dividends.
Cash Dividend Example
Let's assume you own 100 shares in Company ABC on the record date. At the end of the quarter, the company calculates its company earnings. The board of directors then reviews this information and declares a $0.10 dividend per share for the quarter.
This means that you are entitled to $0.10 x 100 shares = $10.
Stock Dividend Example
If Company XYZ declares a 10% stock dividend, then every shareholder will receive an additional 10 shares for every 100 shares they own (when dividends are paid). Stock dividends may be issued when a company doesn’t have cash reserves to pay investors – or needs to conserve cash for reinvesting but still wants to maintain the appearance of paying dividends.
In most circumstances, shareholders can usually sell these new stock dividends on the stock exchange and convert it back into cash. However, the amount received for this sale may be higher or lower than an equivalent cash dividend depending on the share price and time of sale.
Why Dividends Are Important
Dividends are important in the investing world for many reasons.
Dividends Provide an Extra Source of Income
Many investors rely on dividend payments as a source of income. This is especially true for retirees who hold a portion of their investment portfolio in stocks.
Let’s say the prices of your stocks increase over time. You'd be unable to realize these capital gains until you sold your shares. However, if these stocks paid dividends, you’d receive a check in the mail (usually four times a year) for your share of each companies' profits.
Dividends Impact Share Price
Because dividends take money out of the company, they have an impact on the company share price. This typically occurs on the ex-dividend date when share price drops due to shareholders now owning the stock from this date forward.
For example, if a stock is trading at $100 and pays a quarterly dividend of $3 per share, then the stock would open on the ex-dividend date at $97.
Dividends Can Build a Company's Reputation
A stable dividend payout is a sign of business maturity and confidence in cash flow. Once a dividend is established, investors expect that dividend to remain – even during a financial downturn. If dividends are pulled, the number of investors will drop (along with the company’s reputation).
Dividend payments are vital to the relationship between company and investor. During the financial crisis of 2008, we saw General Motors cut their long-running dividends in an effort to avoid bankruptcy. This enraged many former GM employees who lived on dividend payments from the corporation.
Discover How to Invest in Dividends
Curious about dividend investment? Discover how to expand your portfolio – and start profiting from dividends.