A dividend is a payment in cash or stock that public companies distribute to their shareholders. Income investors prefer to earn a steady income from dividends without needing to sell shares of stock.
Understanding Dividends
Dividends are how companies distribute their earnings to shareholders. When a company pays a dividend, each share of stock of the company you own entitles you to a set dividend payment. Dividends can be cash, additional shares of stock, or even warrants to buy stock.
Both private and public companies pay dividends, but not all companies offer them, and no laws require them to pay their shareholders dividends. If a company chooses to pay dividends, they may be distributed monthly, quarterly, or annually. Special dividends are paid on an irregular basis.
Even among companies that pay dividends, not all shareholders are eligible to receive them equally. Preferred and common stock and different classes of stock typically earn varying dividends or none. For instance, the preferred stock generally has a stronger claim to dividends than common stock.
Special Dividends
A special dividend is a one-time bonus dividend payment. Special dividends might be one-off payouts from a company that doesn’t typically offer dividends, or they could be extra dividends in addition to a company’s regularly scheduled dividends.
Companies generally announce special dividends when they’ve been incredibly profitable and want to share earnings among shareholders. Special dividends are not a commitment by a company to continue offering dividend payments at that rate. For example, Microsoft paid a one-time dividend of $3 per share in 2004, equal to $32 billion. Its regular quarterly dividend rate remained 13 cents per share.
Stock Dividends
A stock dividend is a dividend paid as shares of stock instead of cash. You can sell these dividend shares for an immediate payoff, or you can hold them. A stock dividend functions essentially like an automatic dividend reinvestment program (more on that below).
When Are Dividends Paid?
Dividends may be paid monthly, quarterly, or yearly, depending on the company. There are three key dates to know when it comes to dividends: the declaration date, the ex-dividend date, and the payment date.
- Declaration date. This is the date the company’s board or management team announces a dividend will be paid. The board then votes on whether to pay the dividend.
- Ex-dividend date. You must own a dividend-paying stock to receive the dividend on this date. The ex-dividend date is typically one business day before the company checks its stockholder roster to determine who gets a dividend. You won’t receive the related dividend payment if you buy shares on or after the ex-dividend date. Conversely, if you sell your shares on or after the ex-dividend date, you will still receive the related dividend payment.
- Payment date. This is the day shareholders who hold stock on the ex-dividend date receive their dividend payment.
In general, if you own the common or preferred stock of a dividend-paying company on its ex-dividend date, you will receive a dividend.
Which Stocks Pay Dividends?
Stocks commonly pay dividends are more established companies that don’t need to reinvest their profits. For example, more than 84% of companies in the S&P 500 currently pay dividends. Dividends are also more common in specific industries, such as utilities and telecommunications.
Many companies pride themselves on paying dividends regardless of market conditions or other factors. Many investors, particularly retirees, may try to invest primarily or solely in such dividend-paying stocks.
On average, dividend-paying stocks return 1.91% of the amount you invest in dividends, which can provide a higher return than some high-yield savings accounts. However, dividend stocks do not offer the same principal security as savings accounts.
Dividends for Mutual Funds and ETFs
Because they often own dividend stocks, mutual funds and exchange-traded funds (ETFs) may distribute dividend payments to their shareholders. If you own an ETF or mutual fund, you’ll receive your portion of the fund’s dividend income based on the number of shares you own and the company’s representation in the fund. An S&P 500 fund, for example, might pay a dividend yield of 1.77%, while some companies within the S&P 500, like Kohl’s, offer dividend yields above 13% (more on yields below).
Dividends and REITs
A real estate investment trust (REIT) owns or operates income-producing real estate. To be classified as a REIT, 90% of the taxable income these companies earn each year must be paid out in the form of dividends, and 20% of those dividends must be paid as cash.
These traits make REIT stocks attractive to investors who want reliable dividend income and high yields. REITs offer an average dividend yield of 3.8%, more than double what you might get from an S&P 500 fund. REITs focusing on specific sectors, like mortgages, may offer higher yields.
Common Stock Dividends vs. Preferred Stock Dividends
There are two main types of stock: common stock and preferred stock. Every day investors who invest in individual stocks usually hold shares of common stock.
While shares of common stock always have voting rights, it isn’t guaranteed if they offer a dividend. Even if a company has been paying ordinary stock dividends regularly for years, the board of directors can decide to do away with it at any time.
Preferred stock, on the other hand, usually has a more extraordinary claim to dividends. While they don’t have voting rights, preferred stockholders are more assured of receiving dividends at a set rate and are prioritized to receive dividend payments before common stockholders. These regular, set payments mean that preferred stocks function similarly to bonds.
Preferred stock prices are generally also consistent with bond prices and may not offer the potential for growth that most common stock does. However, when a company goes bankrupt, preferred stockholders receive payments before common stockholders. Any company bondholders, however, are paid before preferred stockholders.
What Is Dividend Yield?
The dividend yield is a way of understanding the relative value of a company’s dividend payment. Yield is expressed as a percentage, letting you know what return on investment you make when you earn a dividend from a given company.
Since dividends are paid as a set amount per share, it can be challenging to compare dividend payments across companies, given their different share prices. Dividend yield provides a handy way to measure and compare which stocks pay the most dividends per dollar you invest.
How to Calculate Dividend Yield
To calculate dividend yield, divide the stock’s annual dividend amount by its current share price.
Let’s say the stock ABC is trading at $20 per share, and the company pays a quarterly dividend of 10 cents per share. For the year, ABC’s dividend would be 40 cents. Divide 40 cents by $20 per share to arrive at a dividend yield of 2%.
Dividend yield lets you compare the value of dividends from different companies. Stock XYZ, for example, might pay a higher quarterly dividend than ABC of 20 cents per share for a total annual dividend of 80 cents. Since shares of XYZ are valued at $75 per share, though, the dividend yield is only 1%.
