What are Dividends? How to Become a Dividend Aristocrat

What exactly are dividends and how do they work? When you invest in a company you get paid a portion of a company’s profits as a way to compensate you for your investment. These payments are called dividends and they are a form of passive income.

What are Dividends?

When you own stock in a company directly or through a fund you may receive dividends. A dividend is a distribution of a portion of a company’s profits. They are decided by the board of directors and can be issued as cash payments, as shares of stock or other property. It’s an opportunity for a company to reward shareholder loyalty.

The amount you receive depends on how much stock you own and how much profit there was to divide.

Why Buy Dividend Stocks?

Investors, particularly retired investors, like the steady income that dividend stocks provide and also like the option of reinvesting dividends to buy more shares of stock.

Not All Companies Offer Dividends

Most companies don’t offer dividends, and if they do, they can cancel them if it’s a bad time to make a payout. Companies can increase dividends if times are good.

Startups and some high-growth companies in certain sectors like tech and biotech usually don’t pay dividends because all of the profits are plowed back into the company so they can maintain higher than average expansion and growth.

If a company wants to increase it value (which increases the share price) it may opt to reinvest earnings rather than pay out dividends. Some companies choose to use that money to fund new projects, buy new assets, buy back some of its shares or acquire another company.

What Kind of Companies Pay Dividends?

Bigger well-established companies are more likely to pay out dividends regularly. Companies in certain sectors including oil and gas, financial, healthcare and pharmaceuticals, historically have had some of the highest dividend yields.

Why Pay Them?

A bird in the hand is worth two in the bush. Investors are less sure that they’ll receive capital gains at a later date when earnings are reinvested as retained earnings than they are of receiving current dividend payments. In other words, better the sure thing now.

There are tax reasons too. In some countries income derived from dividends is taxed at a lower rate than regular income. This is particularly an incentive for investors in high tax brackets. We’ll cover taxes below.

If a company has a long track record of paying dividends, eliminating them or reducing the amount might be taken as a sign by investors that the company is in trouble.

The reliable income that dividends can provide is appealing to many investors, so they’ll be more tempted to buy stock in a company that pays them. Paying dividends is also typically a sign that a company is healthy and that management expects future earnings.

When Should You Buy?

Should you buy before or after the dividend payment goes out? Bird in hand theory means you buy before the payment goes out while the stock is more expensive because you can expect a payment soon. Once the payment goes out, the stock will, in the short term, be worthless. For a bigger yield, buy after the payment has gone out.

Cum Dividend

And for your daily dose of the sophomoric, a share is said to be “cum dividend” when it is offered for sale with an entitlement to the next dividend payment attached. See also, “jizz dividend.” Don’t google that, Matt just made that up.

When are Dividends Paid?

If a company is going to pay dividends, shareholders are notified by a press release sent to the big stock quoting services. A record date is set. All investors who own stock as of that date will receive dividends.

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