A dividend is a payment made by a company to its shareholders as a distribution of its profits. Generally, dividends are paid in the form of cash, but they can also come in the form of additional shares of stock or other assets. Dividends are usually paid out regularly, and they represent a way for shareholders to receive a portion of the company’s earnings for their investment.
Dividends are often expressed in terms of "dividend per share," which indicates how much each share of stock is entitled to receive. They are a way for established companies to share their profits with their investors, providing them with a steady stream of income.
Sometimes, a company pays a dividend as part of their dividend policy. This policy is determined by the company’s board of directors, who consider factors like the company’s profit, financial health, and the overall goals of the business. High dividend yields can attract investors looking for a reliable source of income.
Dividends are a critical aspect of how companies reward their shareholders for their investments in the company’s equity. They typically stem from the company’s net profits, which are the earnings left after covering all expenses. Although these profits can be retained within the company as retained earnings for future business activities, a portion of the profits is allocated to shareholders in the form of dividends.
To understand how dividends work, here are the key principles:
Shareholder Approval. The shareholders must approve dividends through voting rights. This ensures that the decision to pay dividends aligns with the shareholders’ interests.
Types of Dividends. While cash dividend is the most common, dividends can also be issued in the form of shares of stock. Additionally, various mutual funds and exchange-traded funds (ETFs) pay dividends to their investors.
Profits and Dividends. Companies typically pay dividends out of their net profits. However, even if a company doesn’t generate substantial profits in a given period, it may choose to continue paying dividends to maintain its track record of distributions. This decision is often influenced by a company’s dividend yield policy.
Board of Directors’ Role. The board of directors plays a pivotal role in the dividend payment process. They have the authority to decide when and how dividends will be issued. This includes determining the frequency of dividend payments, such as monthly, quarterly, or annually. For example, companies like Walmart Inc. (WMT) and Unilever (UL) make regular quarterly dividend payments.
Special Dividends. Companies can also issue non-recurring special dividends, either as a one-time payment or in addition to scheduled dividends. These special dividends are typically paid when a company has excess profits or wants to reward shareholders on a unique occasion. For instance, United Bancorp Inc. declared a special dividend of 15 cents per share on February 23, 2023.
There are several types of dividends that a company can choose to pay out to its shareholders:
Cash Dividends. Cash dividends are the most common type of dividend. Companies generally pay these in cash directly into the shareholder’s brokerage account. Shareholders receive a predetermined amount of money for each share they hold, providing them with a direct cash return on their investment.
Stock Dividends. Instead of paying cash, companies can also pay investors with additional shares of stock. This type of dividend is known as a stock dividend. Shareholders receive additional shares in proportion to the number of shares they already own. Stock dividends can be a way for the company to reward shareholders while conserving its cash reserves.
Dividend Reinvestment Programs (DRIPs). Investors in DRIPs have the option to reinvest any dividends they receive back into the company’s stock. This program allows shareholders to purchase more shares of the company, often at a discount. DRIPs typically aren’t mandatory; investors can choose to receive the dividend in cash instead.
Special Dividends. Special dividends are one-time payments that are issued to all shareholders of a company’s common stock. Unlike regular dividends, special dividends do not recur on a regular basis. Companies often issue special dividends to distribute profits that have accumulated over several years and for which they have no immediate use. These can be a pleasant surprise for shareholders.
Preferred Dividends. Preferred dividends are payouts issued to owners of preferred stock. Preferred stock is a type of stock that functions less like common stock and more like a bond. Dividends on preferred stock are generally fixed and are usually paid quarterly. Unlike common stock, where dividends may vary depending on the company’s performance, preferred stockholders can expect consistent and predictable dividend payments.
Growth and Expansion of Profits. One of the primary benefits of investing in dividend-paying companies is the steady growth of dividends over time. Well-established companies that pay dividends typically increase their dividend payouts from year to year. These companies, often referred to as "dividend aristocrats," have a track record of consistently increasing dividends for more than 25 years. For example, the compounded annual growth rate (CAGR) of the total return for S&P Global Dividend Aristocrats was 2.72% over the last decade (as of Jan. 28, 2022). This growth provides investors with a reliable source of income and an opportunity for capital appreciation.
Dividends Are Helpful in Equity Evaluation. Dividends provide a valuable point of analysis in equity evaluation and stock selection. Unlike some financial metrics that companies can manipulate, dividends offer a solid indication of a company’s financial health. Companies must have real cash flow to pay dividends. Examining a company’s dividend history offers a reliable reference point for assessing its growth and profitability. A company consistently increasing its dividend payments over time indicates steady profitability and resilience in the face of market fluctuations.
Reducing Risk and Volatility. Dividends play a crucial role in reducing overall portfolio risk and volatility. They mitigate losses that may occur due to declines in stock prices. Studies have historically shown that dividend-paying stocks outperform non-dividend-paying stocks during bear markets, suffering less decline in value. While there have been exceptions, like the recent COVID-19 pandemic, dividend stocks have generally been less volatile and more resilient. Stocks with a history of increasing dividends have demonstrated less volatility from 1990 to 2018, according to a Merrill Lynch study.
Dividends Offer Tax Advantages. Dividends are tax-efficient means of obtaining income. Qualified dividends are taxed at substantially lower rates than ordinary income. The IRS classifies qualified dividends, and for individuals in the highest tax brackets, they are taxed at a rate of 20%. Those in lower tax brackets enjoy even lower tax rates on qualified dividends, making them an attractive source of income.
Preserving Purchasing Power of Capital. Dividends help counter the erosion of purchasing power caused by inflation. When an investment generates a return that outpaces inflation, it preserves the investor’s purchasing power. Many dividend yields are designed to outpace inflation, making them a valuable tool for safeguarding capital against the effects of rising prices.
The average stock dividend payment can vary significantly depending on various factors, including the industry and specific stocks within those industries. To provide a general perspective, we can refer to the S&P 500 Index (NYSEMKT:GSP), which tracks the largest publicly traded companies in the United States. The dividend yield for this index, which represents about 80% of the total market capitalization of the U.S. stock market, can serve as a starting point for understanding average dividend payments.
In 2020, before the COVID-19 pandemic, the S&P 500 had a dividend yield of more than 2%. However, as of May 2022, this yield had decreased to approximately 1.37%.
It’s essential to note that individual industries have varying dividend payment practices. Some industries, such as utilities and real estate, often offer higher dividend yields due to the stability of their revenues and slower growth rates. On the other hand, more volatile industries like consumer discretionary goods and technology companies tend to provide smaller dividend payments, as they may prioritize reinvesting profits for growth.
Overall, the average stock dividend payment can fluctuate widely, and it’s influenced by factors such as economic conditions, corporate profitability, and industry-specific characteristics. Investors should consider their financial goals and risk tolerance when selecting stocks based on dividend payments.
A dividend yield is a key financial metric that estimates the dividend-only return of a stock investment. It provides insight into how much income an investor can expect to receive from owning a particular stock, relative to its current market price. The formula for calculating the dividend yield is:
Dividend Yield = (Annual Dividend per Share) / (Stock Price)
Yield and Stock Price Relationship. The dividend yield is inversely related to the stock price. When the stock price falls, assuming the dividend remains unchanged, the yield will increase. Conversely, when the stock price rises, the yield will decrease. This relationship is essential for investors to grasp, as it helps assess the attractiveness of dividend-paying stocks, especially during price fluctuations.
Yield and Company Growth. The dividend yield can vary significantly based on the company’s stage of development. New, smaller companies that are experiencing rapid growth may offer lower average dividend yields because they often reinvest earnings for expansion rather than distributing them as dividends. In contrast, mature companies that are not growing as quickly may provide higher dividend yields. These companies tend to prioritize returning profits to shareholders in the form of dividends.
Sector Variations. Different sectors within the stock market can have varying average dividend yields. Generally, mature companies in sectors with stable and slow growth patterns, such as consumer non-cyclical stocks that produce staple items or utility companies, tend to pay the highest average dividend yields. These companies often have established operations and can afford to allocate a substantial portion of their earnings to dividend payments.
Investors often use the dividend yield as one of many factors to assess the attractiveness of an investment. A high dividend yield might indicate an opportunity for income, but it should be considered in the context of the company’s financial health, growth prospects, and overall investment goals. Conversely, a low dividend yield may not be a negative sign if the stock offers potential for capital appreciation.
Investing in dividend stocks can be a wise choice for income-seeking investors. Here’s how to invest in dividend stocks:
Investment Options. Investors have several options for dividend investments, including individual stocks, mutual funds, and exchange-traded funds (ETFs). Each option offers a different level of diversification and risk, so the choice depends on your investment goals and risk tolerance.
Stock Selection. When choosing individual dividend-paying stocks, investors can use financial models like the dividend discount model or the Gordon growth model. These models rely on anticipated future dividend streams to value shares and assess whether they are undervalued or overvalued.
Dividend Yield. To compare multiple stocks based on their dividend payment performance, investors can use the dividend yield factor. The dividend yield is a percentage of the current market price of the company’s share. It helps assess how much income you can expect to receive from your investment relative to the stock’s current price.
Total Return Factor. In addition to the dividend yield, another essential performance measure is the total return factor. This metric takes into account not only dividend income but also interest, increases in share price, and any capital gains. It provides a more comprehensive view of the overall returns generated by your investment.
Tax Considerations. Tax implications play a crucial role in dividend investing. Investors in higher tax brackets often prefer dividend-paying stocks, particularly if their jurisdiction offers favorable tax treatment. Some countries, like Greece and Slovakia, have lower tax rates on dividend income for shareholders. In places like Hong Kong, dividend gains are entirely tax exempt. Understanding the tax treatment of dividends in your region can help you make more tax-efficient investment choices.
Diversification. To manage risk, consider diversifying your dividend stock portfolio. Investing in a mix of stocks from different industries can help spread risk and provide stability, especially during economic downturns.
Reinvestment Options. Many dividend stocks offer dividend reinvestment programs (DRIPs), allowing you to reinvest your dividends back into the same stock or purchase additional shares. This strategy can help accelerate the growth of your investment over time.
Long-Term Perspective. Investing in dividend stocks is often most effective when approached with a long-term perspective. Dividends can provide a steady income stream and may continue to grow over the years, making them an attractive option for long-term investors.