By Gina Gallagher | Citizens Contributor
Key takeaways
- Dividend payments represent portions of profits companies share with their stockholders, usually on an annual or quarterly basis.
- The dividend you receive is based on the number of shares you own and the percentage of profit a company will use for dividends.
- Not all companies pay dividends, though larger, more established companies are more likely to offer them.
Chances are, you’ve seen stories about well-known companies paying dividends.
But what do those dividends actually mean for investors? And more importantly, what do they mean to the most important investor or potential investor of all … you?
To get the story on that, we need to answer some key questions:
What are dividends?
Dividends are payments companies make to reward their shareholders for holding on to their stock. They represent a portion of a company’s profit and can be paid in cash, stock, or some other property. When a company announces a dividend, it’s agreeing to pay a certain amount per share of stock at a certain point in time. Hence the meaning of the phrase “paying dividends.”
Who pays dividends
Companies that offer a dividend payout tend to be larger, more established companies with proven track records of reliable growth and stock that doesn’t fluctuate widely. In some cases, a high dividend may mean the company is in distress and is trying to attract investors.
However, not every public company pays dividends; in fact, most don’t. Rather than distribute portions of the profit they make to shareholders, non-dividend-paying companies may choose to retain all of the income they make and invest it back into the business to fund growth or build value. That’s often the case with startups or companies in the high tech or bio tech fields that have higher growth potential and require further capital to fuel it.
Keep in mind that just because a company issues a dividend payout or has in the past doesn’t mean it will always do so. It’s conceivable that, since dividends are paid from profits, a company having financial difficulties could choose to greatly reduce dividends or even choose not to pay them at all.
How could dividend stocks help you?
There are some great advantages to investing in dividend stocks, including:
- Additional income: Dividends allow you to get additional return on your investments by generating income. For those living in retirement, that income can be a powerful benefit.
- Portfolio growth: You also have the option to reinvest dividends instead of receiving payouts, allowing you to increase shares and build your portfolio.
- Manage stock market volatility: In general, stocks that pay dividends are less volatile and have historically performed well.
How are dividends calculated?
The dividends paid to you depend on two factors:
- The number of shares you own
- The amount of profit the company will share in dividends
Companies that announce dividends do so as either a percentage or a dollar amount. If a company announces a dividend as a dollar amount, the dividend is calculated by multiplying the number of shares you own by the amount of the dividend paid. So if you own 1,000 shares of a company, and that company pays a dividend per share of $0.68, you would be paid $668.
The amount a company pays in dividends is measured by the target payout ratio, which is a percentage calculated by dividing the dividends paid over a period by the company’s net income. For example, if a company pays $20,000 in dividends, but earned $100,000 in total net income, the target payout ratio would be 20%.
Another important calculation in understanding dividends is the dividend yield, which is the ratio of a company’s annual dividend relative to the share price at a particular point in time. So if a company announces that it will have an annual dividend of $0.20 per share, and the stock is trading at $50, the dividend yield would be 4%. The dividend yield can be a valuable measure to help you evaluate and compare dividend stocks when making investment decisions.
When are stock dividends paid?
Most dividends are paid on a quarterly or annual basis, though some are paid monthly or bi-annually. Companies may also announce special dividends that are declared at a certain time, like when a company has excess income.
When a company pays cash dividends, they send the money to a shareholder’s brokerage account. Some companies may choose to pay dividends in the form of stock or other property.
If a company declares a dividend for a stock you own, it’s important to pay attention to the ex-dividend date. This is the date by which you would have had to own the stock in order to receive the dividend. If you purchased a stock on the ex-dividend date or later, you would not be eligible to receive the dividend.
Ready to see where dividends fit into your investment story?
Dividends can be a great way to generate investment income and build your investment portfolio. Of course, as with any type of investment, it’s important to review your goals, timeframe, and needs to ensure you’re making the right decisions for you.
A Citizens Bank Wealth Management Advisor can help you build a long-term investment strategy with your goals in mind.
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