What Is a Dividend and How Do They Work?

Dividends are regular payments made to investors who own a company's stock. Not all stocks pay dividends.

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what are dividends

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Dividends are payments made by a company to owners of the company's stock. They are a way for companies to distribute revenue back to investors, and one of the ways investors earn a return from investing in stock.

But not all stocks pay dividends — if you are interested in investing for dividends, you will want to specifically choose dividend stocks.

How do stock dividends work?

A dividend is paid per share of stock — if you own 30 shares in a company and that company pays $2 in annual dividends, you will receive $60 per year. Companies generally pay dividends in cash to the shareholder's brokerage account, though some pay dividends in new shares of stock instead. Companies may also offer dividend reinvestment programs, called DRIPs, which allow investors to reinvest the dividend back into the company's stock, often at a discount.

How often are dividends paid?

In the United States, companies usually pay dividends quarterly, though some pay monthly or semi-annually. 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.

Investors must own the stock by the ex-dividend date to receive the dividend.

The ex-dividend date is extremely important to investors: Investors must own the stock by that date to receive the dividend. Investors who purchase the stock after the ex-dividend date will not be eligible to 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.

One note: Investors who don't want to research and pick individual dividend stocks to invest in might be interested in dividend mutual funds and exchange-traded funds. These funds hold many dividend stocks within one investment and distribute dividends to investors from those holdings.

What is a dividend yield?

Financial websites or online broker platforms will report a company’s dividend yield, which is a measure of the company’s annual dividend divided by the stock price on a certain date.

The dividend yield evens the playing field and allows for a more accurate comparison of dividend stocks: A $10 stock paying $0.10 quarterly ($0.40 per share annually) has the same yield as a $100 stock paying $1 quarterly ($4 annually). The yield is 4% in both cases.

Yield and stock price are inversely related: When one goes up, the other goes down. So, there are two ways for a stock’s dividend yield to go up:

  • The company could raise its dividend. A $100 stock with a $4 dividend might see a 10% increase in its dividend, raising the annual payout to $4.40 per share. If the stock price doesn’t change, the yield becomes 4.4%.

  • The stock price could go down while the dividend remains unchanged. That $100 stock with a $4 dividend might decline to $90 per share. With that same $4 dividend, the yield would become just over 4.4%.

For most stocks, anything above a 4% yield should be carefully analyzed, as it could indicate the dividend payout is unsustainable.

However, there are some exceptions to this 4% rule — specifically, stock sectors that were created to pay dividends, including real estate investment trusts. It's not unusual for REITs to pay safe yields in the 5% to 6% range and still have growth potential.

What is a dividend payout ratio?

One of the quickest ways to measure a dividend’s safety is to check its payout ratio, or the portion of its net income that goes toward dividend payments. If a company pays out 100% or more of its income, the dividend could be in trouble. During tougher times, earnings might dip too low to cover dividends. Generally speaking, investors look for payout ratios that are 80% or below. Like a stock's dividend yield, the company's payout ratio will be listed on financial or online broker websites.

Types of dividends

The most common type of dividends are those paid on a company’s common stock. There are also two other types of dividends, which occur infrequently.

  • A special dividend is a payout on all shares of a company’s common stock, but it doesn’t recur like a regular dividend. A company often issues a special dividend to distribute profits that have accumulated over several years and for which it has no immediate need.

  • A preferred dividend is issued to owners of preferred stock. Preferred stock is a type of stock that functions less like a stock and more like a bond, usually with fixed quarterly payments. Unlike dividends on common stock, dividends on preferred stock are generally fixed.

Stocks that pay dividends

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, tech or biotech companies rarely pay dividends, because they need to reinvest profits into expanding that growth.

Once a company establishes or raises a dividend, investors expect it to be maintained, even in tough times. The most reliable American companies have a record of growing dividends — with no cuts — for decades. Investors often will devalue a stock if they think the dividend will be reduced, which lowers the share price.

Examples of companies that pay dividends include Target, Apple, CVS, Disney, Exxon, Bed Bath & Beyond and PepsiCo.

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