What Are Dividends?

Dividends are payments made by a company to owners of the respective company’s stock. They serve as a way for companies to distribute revenue back to investors, and are one of the ways that investors earn a return from investing in stock. In the U.S., companies usually pay dividends quarterly, though some pay on a monthly or semi-annually basis. Importantly, a dividend is paid per share of stock—so if you own 40 shares in a company and that company pays $3 in annual dividends, you will receive $120 per year. However, not all stocks pay dividends. In this article, I provide you with more information on how dividends work and flush out why some stocks may pay their stockholders dividends and why others might not.

How Do Dividends Work?

Companies generally pay dividends in cash to the shareholder’s brokerage account, however some may opt to pay dividends in new shares of stock instead. Companies may also offer dividend reinvestment programs, called DRIPs, which allow investors to reinvest this dividend back into the company’s stock, usually at a discount. A company’s board of directors must approve each dividend, and the company will then announce when the dividend will be paid, the amount of the dividend, and the ex-dividend date.The ex-dividend date is extremely important to investors as you me be a stockholder by that date to receive the dividend. If you purchase the stock after the ex-dividend date you will not be eligible to receive the dividend. Even if you sell the stock after the ex-dividend date you are still entitled to receive the dividend.

Understanding Dividend Yield

Financial websites or online broker platforms will often report a company’s dividend yield. This figure is a measure of the company’s annual dividend divided by the stock price on a certain date, and serves as a way for a more accurate comparison of dividend stocks. For example, a $20 stock paying $0.20 quarterly ($0.80 per share annually) has the same yield as a $100 stock paying $1 quarterly ($4 annually). In both cases the yield is 4%. Yield and stock price are inversely related—as when one goes up, the other goes down. So for a stock's dividend yield to go up either the company must raise its dividend payment or the stock price must decrease.

Generally speaking, a 4% dividend yield represents the upper limit for a sustainable dividend payout. However, there are some exceptions to this 4% rule, most notably real estate investment trusts. It is not uncommon for REITs to pay safe yields in the 5% to 6% range and still have growth potential. One of the best ways to measure a dividend’s safety is to check its payout ratio, which is the portion of its net income that goes toward dividend payments. If a company pays out 100% or more of its income, the dividend is unlikely to be continuous. For example, during tougher times stoked by the Covid-19 pandemic, earnings might dip too low to cover dividends. Because of this, investors tend to look for payout ratios that are 80% or below. Like was the case with a stock’s dividend yield, the company’s payout ratio is listed online by financial service companies or other online brokerages.

Stocks That Pay Dividends

Stocks that pay dividends are stocks from companies that can provide a stable and growing income stream. As a result, dividends are more likely to be paid by well-established companies that no longer need to reinvest as much money back into their own operations. Conversely, high-growth, tech or biotech companies rarely pay dividends, because they need to reinvest their profits into expanding that growth—think Uber and Tesla. And importantly, once a company establishes or raises a dividend, investors expect it to be maintained no matter what. The most reliable American companies have a record of growing dividends, with no cuts at all, for decades. A company reducing its dividend is viewed negatively by investors and will often lead to the stock being devaluing and the share price subsequently falling in price.

Special Cases

In the article thus far, I have covered the most common type of dividend: a dividend paid on a company’s common stock. There are also two other types of dividends, though occur infrequently. A special dividend is a payout on all shares of a company’s common stock, but it isn’t recurring like a regular dividend is. A company will often issue a special dividend to distribute profits that have accumulated over several years and for which it has decided to redistribute back to its stockholders. And a preferred dividend is a dividend that is issued to owners of preferred stock, where preferred stock refers to a type of stock that acts more like a bond, and pays out on a fixed and quarterly basis.