Dividend Definition, Types & Examples

What is a Dividend?

A dividend is, by definition, a distribution of a portion of a company’s earnings, which typically gets paid quarterly or annually to the shareholders. The board of directors typically decides if and how dividends should be paid to the shareholders. It is quoted as a sum of money paid per share owned.

Example: If a company pays $4 per share annually in dividends, an investor owning 100 shares would receive $400. Dividends provide an incentive for investors to buy and hold a company’s stock, as they can receive regular income payments in addition to capital appreciation.

The higher the dividend relative to its price per share, the higher the so-called dividend yield.

Some companies don’t pay dividends at all, some pay only minimal dividends, and some companies have a dividend yield of over 20% annually.

Keep in mind that if you hold stocks that pay dividends, the stock will trade ex-dividend the day after the dividend date. That means that the stock price will be reduced by the same amount that you get paid in the form of a dividend.

Types of Dividends

The most common is a cash dividend, paid in cash, but there are other types. A stock dividend is paid in additional shares instead of cash. A property dividend distributes assets from the company’s reserves. There are also special one-time dividends or dividend reinvestment plans that reinvest cash payouts into more shares.

How Dividends Work

Companies pay dividends from their after-tax profits or retained earnings. The board decides to pay out a portion as dividends based on their dividend policy. There are declaration, holder-of-record, and payment dates involved.

Once declared, the company will debit its retained earnings and credit dividends payable account until paid out.

Over time, the paid-out dividends can make a whole difference in terms of performance calculation.

Example:

Let’s say you hold shares of a company that pays $5 per share in dividends per year. When you bought the shares, the price per share was at $50. Now, 10 years later, the cost per share is still at $50.

Everyone who does research for the best-performing stocks won’t find your stock at all since, in terms of performance, it is +-0%.

However, you received 10 years of a $5 dividend, and the stock always trades ex-dividend. That means you had an income of $50 in 10 years, and your shares are at the same value after 10 years.

If you do the math, you know that you made a profit of 100% in 10 years, just of the paid dividends.

So, whenever you do stock research, it’s a good idea to include dividend payments in the performance calculation to get a real picture of the situation.

Calculating Dividends

There are several metrics used to calculate and analyze dividends, like the dividend per share which is the total dividends paid out divided by shares outstanding.

The dividend yield expresses the dividend as a percentage of the current share price. The dividend payout ratio (dividend yield) shows the percentage of net income paid as dividends.

Dividend Taxation

For tax purposes, qualified dividends receive favorable tax treatment compared to ordinary income if the investor meets certain IRS holding period rules.

Qualified dividends are often taxed at the lower long-term capital gains rates, while non-qualified dividends get taxed at higher ordinary income tax rates. The actual dividend tax rates vary based on one’s taxable income level and the region in which you live.

Dividend Investing Strategy

Dividend investing is a popular investment strategy that focuses on building a portfolio of consistently dividend-paying stocks that can provide a stable source of income.

Dividend investors look for companies with a long track record of growing dividends year-over-year. The strategy is popular among retirees or income-oriented investors.

Dividend Policies

A company’s dividend policy defines various factors. For example, how much of the company earnings will be paid out as dividends versus retained for growth opportunities?

So, the policy makes clear how much of the company’s earnings will handed through to its shareholders and how much of the earnings will be reinvested in the company’s growth.

Both can be a good and valuable decision. For you as an investor, what counts is the overall return on investment. If your company does not pay any dividends, it can be okay if the stock price goes up in a satisfying way.

In this case, you made your money with the stock price gains.

In addition, it is also good if the stock remains at the price level you bought the shares at but pays a high dividend over many years. In this case, you made most of your money with dividends.

The payout ratio depends on their business life cycle, cash needs, and growth plans. Well-established companies tend to have higher dividend payouts, while growth companies retain more earnings to reinvest.

You can use a stock screener to sort all stocks in the region you want to invest in by the dividend amount or dividend yield percentage. This way is the best way to find dividend-paying hidden gems.

Dividend History and Facts

One of the first publicly traded companies to pay dividends was the Dutch East India Company in the 1600s. Dividend investing grew in popularity during the 1900s.

Today, dividends make up a significant percentage of total equity investor returns over the long term. Companies that maintain or raise dividends tend to outperform over time.

Alexander Voigt, CEO
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Alexander Voigt is the founder of DayTradingZ, was a regular contributor to Benzinga and has been featured and quoted on leading financial websites such as Investors.com, Capital.com, Business Insider and Forbes.