Dividends are payments from companies to their shareholders, usually either in the form of cash or additional stock. Cash dividends are paid on the basis of the number of shares you own, so if you own 100 shares you will receive 100 times as much from a dividend as someone who owns one share of the stock. You must own the stock before a date known as the ex-dividend date to receive the dividend.
Companies that pay dividends do so based on how many shares you own. Sometimes different classes of stock will receive different types of dividends.
Stocks That Pay Dividends
When people buy stock in a company, they're usually hoping to get some financial reward in the future. Some of that may come from selling the stock at a higher price in the future, but in many cases some of the reward comes from a dividend paid by the stock-issuing company.
A dividend is the term for a company returning a share of its profits to investors. A cash dividend is paid based on how many shares of the company you own, so a company might declare a dividend of some amount like 10 cents per share. Some companies have different classes of stock, such as preferred stock and common stock, that might at times receive different dividends. Also, a company that is liquidating might make a one time cash payment, called a liquidating dividend, as a way of returning some of shareholders' investment.
Many mutual funds, index funds and similar investment opportunities also pay dividends to investors over time. These are often generated by dividends in the stocks that the funds buy on behalf of investors.
Understanding Dividend Yield
The ratio of the total dividend amount paid out per share in a year to the share price is called the dividend yield, and it's usually written as a percentage. For instance, a company with a share price of $10 per share paying 30 cents per share in dividends over a year would have a 3 percent dividend yield.
For a stock with a relatively stable share price, looking at dividend yield per share can be a good, simple way to compare an investment to other opportunities like interest-paying bonds or bank accounts. It can also be useful to compare per-share dividend yields between similar stocks, such as stocks in the same industry, to decide which is worth investing in.
Dividend yields for individual companies and for industry sectors are often listed by brokerage sites and financial news information sites.
Stock and Cash Dividends
Some companies pay what's called a stock dividend rather than a cash dividend. This gives each shareholder additional shares in proportion to how many they already have. For instance, a company might give five additional shares to each shareholder for each 100 shares they already have. In some cases, this can lead to investors owning fractional shares of stock, which can be sold through a brokerage that will combine them with other shares from other investors in the same situation.
Companies will also sometimes pay out a dividend in stock in a subsidiary company or an interest in other company assets. This is called a property dividend, and it's also paid in proportion to how many shares a given shareholder has. This kind of dividend is less common than cash or stock payments.
It's also possible for a company to pay a mix of cash and stock at one time.
Understanding the Ex-Dividend Date
How much you get from a dividend payment depends on how many shares of the company's stock you own, and whether you receive any dividend payment at all depends on when you own the stock.
You must own the stock before a date known as the ex-dividend date in order to receive the proceeds of the dividend. If you buy the stock afterward, you won't be able to collect the dividend, although you would be able to collect future dividends. The date is usually announced when the dividend is announced, along with the dividend amount to be paid.
If you own some shares before the ex-dividend date and buy more after, you will only be able to collect dividends based on the shares you held before the date. If you're buying or selling stock, you may want to plan your transactions to maximize your dividends, although the stock price may naturally decrease after the ex-dividend date to take the lack of dividend into account.
Reinvesting Your Dividends
When you receive a cash dividend, you can often choose to reinvest the dividend in the same stock or fund rather than take it as cash. This is an easy way to boost your investment in a dividend-paying stock or fund that you like and can prove to be lucrative over time. As time goes by, you'll end up owning more and more of the stock and therefore receiving a larger dividend since you will own more shares.
Some companies offer a dividend reinvestment plan, or DRIP, where you can automatically buy additional shares using your dividends with no commissions or other fees. You can also often set up dividend reinvestment through a brokerage firm. Check to see what the brokerages you're considering offer and whether there are any associated fees.
Note that reinvested dividends are still subject to taxes.
Dividends and Your Taxes
Like other income, dividends that you receive from companies and funds that you invest in are subject to income tax. Some dividends, called qualified dividends, are taxed at the long-term capital gains rate, which is 15 percent for most investors. Some taxpayers pay 0 percent or 20 percent on long-term gains depending on overall income.
Other dividends, usually called ordinary dividends, are taxed at the ordinary income rate like money from bank interest or earned by working. That rate is higher for most people than their capital gains tax rate.
You will normally receive a tax form called 1099-DIV when you receive at least $10 in dividends from a particular company. Include it with your tax return or enter the information online into a digital return when you file your taxes. Note that dividends paid by credit unions, which effectively function like bank interest, are taxed like interest and reported on the 1099 form used for interest, not dividends.
Share Buybacks and Stock Splits
Another way that companies can return money to investors is by buying back stock. This can also be done to boost the company stock price. Share buybacks are usually optional. Companies will either invite shareholders to offer to sell shares, a process known as a tender offer, or they will simply buy shares on the public market like ordinary investors do.
Stock splits, like stock dividends, change the amount of shares that each investor owns in proportion to how many they owned going into the process. They don't really award new shares though, but simply replace old shares with new shares in a specified ratio. A stock split typically replaces old shares with a greater number of new shares, such as a two-for-one stock split, while a reverse stock split can go in the opposite direction, replacing old shares with a fewer number of shares.
Stock splits are often done to increase or reduce the stock price to make the stock desirable and affordable to a larger group of potential investors. Stock splits can also lead to investors owning fractional shares in a company.
Video of the Day
- Corporate Finance Institute: Dividend Yield
- Investopedia: Introduction To Dividends: Terms to Know and Other Basics
- Investopedia: Dividend
- Investopedia: Property Dividend
- Investopedia: Liquidating Dividend
- Investopedia: Fractional Share
- Investopedia: Dividend Reinvestment Plan
- Schwab: Why and How to Invest in Dividend-Paying Stocks
- Investopedia: Qualified Dividend
- IRS: 1099 DIV Dividend Income
- Investopedia: 1099-DIV
- IRS: Instructions for Form 1099-DIV
- Investopedia: Why Would a Company Buy Back its Own Shares?
- Investopedia: Preferred Dividends