When we hear the word “dividend,” we may have flashbacks to a sixth-grade math class and think about a number being divided by another number; however, in the finance realm, the meaning is more fruitful. In financial terms, a dividend is an amount of money paid by a company to its shareholders out of its profits. Dividends can be paid in cash or stock, with cash dividends being the most common form. Investing in dividend-paying stocks is a popular investment strategy for investors looking to supplement their income via their investments, especially in today’s low-interest-rate world where money markets and certificates of deposit (CDs) – two types of federally-insured, low-risk savings accounts that earn interest – are not yielding what they earned ten years ago.
Generally, as companies become more profitable, they realize they have extra capital that does not need to be reinvested in the company in order to keep the company growing. When this happens, many companies elect to pay a portion of their profits to their shareholders as a dividend. A publicly-traded company that pays dividends is known as a dividend stock, and the money that drives dividends comes from a company’s net profits. Although a dividend-paying company keeps a majority of its profits internally, known as retained earnings, to fund its business, a portion of the earnings is divided among shareholders – hence “dividends” – to reward them for their investment in and support of the company. That being said, publicly-traded companies that pay dividends typically produce suitable profits.
Now, how is the amount of a dividend determined and when are dividends rewarded to investors? Given the link between dividends and a company’s profits, dividends are typically distributed to investors on a quarterly basis according to the company announcing its quarterly earnings. The board of directors of a publicly-traded company is the group that determines the issuing of dividends, and the board can decide to issue these sums at various time frames and with varying payout rates. Most dividends are paid out monthly, quarterly, or annually. Even if a dividend-paying company experiences meager profits, the company will still issue a dividend, albeit smaller than usual, to uphold its track record of doing so. If a company experiences particularly strong performance and a favorable outlook for future growth, it may even reward a one-time special dividend in addition to a scheduled dividend. A few big-name dividend payers that many of us will recognize are Apple, J.P. Morgan, and Coca-Cola.
An important note to make is that not all high-earning companies pay dividends. Most notably, Amazon, Facebook, and Alphabet, Google’s parent company, have historically declined to issue dividends to shareholders. The companies that opt against dividend payments are typically quickly expanding and growing companies that declare it is financially wiser for them to reinvest the company profits entirely back into the organization to support its pivotal growth and expansion. These companies essentially want to invest as much as possible into future growth, and investors still favor these stocks because if the company continues to grow, shareholders’ investments will too.
All in all, investors value the companies that reward shareholders with dividends because of the innate steady-income nature of these investments. Dividends are one of the easiest ways for companies to reward their investors and deliver their shareholders value beyond typical investment growth. Lastly, corporations that issue dividends send a clear message around the future financial stability and strength of their companies, enticing many dividend-stock investors to stay loyal to such stocks for the long term.
Questions and/or interested in how this applies to your financial life?
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