Stock Dividends: 9 Things to Know Before Investing

Stock Dividends: 9 Things to Know Before Investing

What exactly are stock dividends?

If you’ve been wondering about the answer to that question, this post is for you!

Dividends are regular distributions of cash or stock by a company to its shareholders. The payments and amounts are typically determined by a company’s board of directors.

If you invest in stocks that pay higher dividend amounts, it can really add up over time in your investment portfolio.

1. How Do Dividends Work?

Dividends are a way for companies to distribute their earnings to shareholders. Dividends are not automatically paid. They have to be approved by the shareholders through their voting rights.

Both publicly-traded and private companies can pay dividends, but not all companies offer them, and there is no law that requires the payment of dividends.

A dividend is usually paid on a per share basis. For example, if you own 100 shares of stock in a company and the company pays out $5 in annual cash dividends, then you would receive $500 per year.

2. Dividends Are a Meaningful Part of Stock Returns

Looking back over the better part of the last century, Dividends have accounted for more than 40% of the total returns of the S&P 500. The S&P 500 is an index that features 500 leading publicly traded companies in the U.S.

Even though the percentage of dividend pay outs has declined in the past several decades, mainly because of high-growth technology companies, they can still have an impact on your investment portfolio.

Consider this representation of the impact of dividends on S&P annualized returns:

3. How Do You Get Dividends?

Cash dividends are the most common, but they can also be issued as shares of stock or other property.

Dividends are usually paid on a monthly, quarterly, or yearly basis, with quarterly being the most common. Some mutual funds and exchange-traded funds (ETFs) also pay dividends.

There are four dates that are important when understanding when dividends are paid:

  • Declaration date: This is the date that a company’s board of directors or management announces that a dividend will be paid. The company still has to vote on whether or not to actually pay the dividends.
  • Ex-dividend date: To be eligible to receive the dividend, you must own the stock by this date. For example, if the ex-dividend date is April 1, then you must own the stock at least by the day prior to be eligible for the dividend payout. This date is usually one business day prior to the date of record.
  • Date of record: This is the date on which a company checks its records to identify shareholders of the company. An inv
  • Payment date: This is the date that the dividends will actually be paid out. When the dividends are paid, the cash will be deposited into your brokerage account.

4. Do All Stockholders Get Dividends?

Not all shareholders are eligible to receive dividends. Companies can have different classes of stock, such as preferred and common stock. Preferred stock shareholders usually have a stronger claim to dividends than common stock shareholders.

Preferred stock shareholders have priority over a company’s income, but they do not have voting rights. Common stock owners have voting rights, but are last in line when it comes to company assets.

Basically, it depends on what type of dividends a company decides to payout.

5. What Types of Dividends Are There?

There are several types of dividends a company can elect to pay out to shareholders:

  • Cash dividends: Cash dividends are the most common type. These are generally paid in cash to a shareholder’s brokerage account.
  • Stock dividends: A company can elect to pay investors with additional stock shares instead of paying cash.
  • Dividend reinvestment programs (DRIPs): DRIPs allow investors to reinvest dividends to purchase more stock. Sometimes this can be at a discount.
  • Special dividends: Special dividends are paid out to common stock shareholders, but they don’t occur at regular intervals. A special dividend is sometimes issued when a company wants to distribute profits that have accumulated over several years that they don’t have an immediate need for.
  • Preferred dividends: Preferred dividends are paid to preferred stock owners. These type of dividends are usually paid quarterly and are generally fixed, unlike dividends on common stock.

6. How to Evaluate Dividends

Before investing in dividend-yielding stocks, it’s important to learn more about a company’s dividends and compare them to similar companies.

Key dividend metrics to consider, all of which can be found on financial or broker websites:

  • Dividend per share (DPS): The DPS calculation for a stock shows the amount of dividends distributed by a company for each share of stock during a certain time frame. Reviewing DPS figures will allow you to see which companies have been able to grow their dividends over time.
  • Dividend yield: The dividend yield is a measure of the company’s annual dividend divided by the stock price on a certain date. There are two ways for a stock’s dividend yield to increase:
    • The company could increase its dividend. If the stock price is unchanged, then that would cause the dividend yield to increase.
    • The stock price could decrease. If the dividend remains unchanged, then that would cause the dividend yield to increase.
  • Dividend payout ratio: This is the portion of a company’s net income that goes toward paying dividends. A dividend could be in trouble if a company pays out more dividends than it’s income. Investors generally look for payout ratios below 80%.

7. Why Do Some Companies Not Pay Dividends?

Companies that are newer or that are still growing are less likely to pay dividends. This is because they are reinvesting their profits back into the company for growth.

One of the reasons why dividend payouts in the past few decades have been lower than in previous decades is because of the explosion of technology companies. Many of them are newer and are hyper focused on growth instead of paying dividends.

Surprisingly, these large technology companies still do not pay dividends: Alphabet (Google), Amazon, and Meta (Facebook).

8. Can You Reinvest Dividends?

If your brokerage offers a Dividend Reinvestment Program (DRIP), then you can have your dividends automatically reinvested by purchasing micro or fractional shares on the company’s stock.

If you don’t really need the income right now, choosing to reinvest your dividends can be a great way for your investment portfolio to compound and grow faster.

Check out my related How Does Compounding Affect My Investments? blog post to learn more about compounding.

9. Which Companies Pay Dividends?

The highest dividend-paying companies are usually larger, more established companies that have more predictable profits. These kinds of companies want to maximize shareholder wealth in ways aside from normal growth.

Companies in the following sectors have historically maintained a regular record of dividend pay outs:

  • Consumer staples and materials
  • Oil and gas
  • Banks and financial institutions
  • Healthcare and pharmaceuticals
  • Telecommunications services
  • Energy and utilities

Startups and high-growth companies, especially technology-related companies, tend to not offer regular stock dividends.

Conclusion

Adding dividend-paying stocks to your investment portfolio can generate an extra stream of income. Definitely make sure you do your homework, though, and thoroughly review financial information for the company or fund before you jump into buying. Make sure it’s an all-around sound investment. If you are unsure if investing in dividend-paying stocks or funds is right for you, reach out to an investment professional for additional guidance.

Check out some of my other posts on saving, making, and investing money:

Disclaimer: This information is intended for educational purposes and is not tailored for the needs of any specific investor. It is important to conduct your own analysis and research before making any investment.  It is recommended to independently research and verify or seek financial advice from a professional in connection with any information on this website before using it to make an investment decision or otherwise.

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