Most people know that a dividend is money that a company pays out to its investors every so often. But where does that money come from, and how is a company able to afford them? Read on, because today’s post is a beginner’s guide to how dividends work.
What is a Dividend?
So you know that a dividend is something a company pays out to investors, but let get into the details a bit more. Dividends are paid out and expressed on a per-share basis; in other words, if a company declares a $4 dividend, that $4 is paid out for each share the company has outstanding. In this example, if you owned 100 shares when the $4 dividend was recorded (more on that later), you would receive a total of $400 from the company.
Dividends don’t just come in cash form, either. They can also be awarded as stocks, or portions of additional stock. While they’re normally paid out in regular intervals, companies sometimes issue special, one-time dividends when they’re sitting on extra cash.
Where do dividends come from?
When a company makes a profit after all expenses are taken into consideration, it will often reinvest that money to help continue to grow the business. Sometimes, though, the company doesn’t need all of the profits it makes in order to keep growing. In these instances, it might pay a portion of those profits to investors. That’s where the dividend comes from – it’s paid for out of a company’s profits.
It’s important to know that not all profitable companies pay dividends, and just because a company doesn’t pay a dividend, doesn’t mean it’s a bad investment choice. Often, younger, growing companies need to reinvest every dollar of profits they make in order to keep scaling the business. Dividends are usually (not always) paid out by larger, more established companies.
How often are dividends paid out?
In North America, most companies pay dividends quarterly. There are a large number of investment funds, however, that pass along smaller portions of these dividends on a monthly basis, to help provide a smoother cash flow to investors. In these cases, it’s not that the companies are paying monthly dividends – they still pay quarterly – but rather that the fund is sandbagging a little bit so that it can pay more consistently. This is nice if you’re retired and like to manage a monthly budget!
What are the dividend record and ex-dividend dates?
They sound scary, but their bark is worse than their bite! Here’s the thing: when determining who to pay dividends to, companies need to pick a point in time when they look at their records to see who they need to pay. The date they choose for that is called the dividend record date.
Another important date is the ex-dividend date, which is the date that the company’s stock trades without the benefit of the upcoming dividend. If you buy a stock on or after this date, and before the dividend payment date, you won’t receive the dividend when it gets paid out.
This isn’t the end of the world, because a stock’s price also drops by the amount of the dividend during this same timeframe. All other things equal, you’ll get the same value by buying the stock, no matter whether you buy it before or after the ex-dividend date.
The reason companies go ex-dividend is that they need time to gather their data in preparation of the upcoming payment – it’s not a trick or anything like that, and the vast majority of investors don’t need to worry too much about it.
Wrapping it Up
So there you have it, dividend 101. Not much to them, really! They’re paid out by profitable companies who don’t need to hang on to all the funds, they’re usually paid quarterly, and they come in both cash and stock forms. In a later post, we’ll talk about the role dividends can play as part of your overall investment strategy, but for today we’ll leave it at that!
