Define Dividend In Simple Terms
A dividend is an amount of money paid by a company to its shareholders.
Quarterly is the most common frequency of payment, but a company can also choose to pay monthly, semi-annually, or annually.
Dividends can alternatively be “special,” meaning that they are a one-time payment that won’t repeat (or won’t repeat at the same amount), but more often dividends are paid on a schedule.
What Is a Dividend In Finance?
The money used to pay dividends comes directly from the income of a company.
There are many reasons why a company might choose to pay out this money to investors instead of spending it elsewhere.
Primarily, dividends are paid when a company is earning a significant income and has no reasonable use for the funds remaining after paying other dues.
This occurrence is rare in smaller businesses or businesses that are investing in rapid growth, but common in corporations with good cash flow that have reached a titanic size, such as Walmart.
With nowhere left to open new stores and a production rate that more than meets demand, Walmart uses some of its excess cash to pay dividends as a reward to its many investors.
Some companies have grown their dividend payments for over 25 consecutive years, and are called dividend aristocrats.
A company’s dividend sustainably is of paramount importance to investors.
Dividend sustainably is how likely it is that a company will be able to maintain or increase its dividend payments.
Dividend yield refers to the percentage of the share price that gets paid back as a dividend.
For example, if shares sell for $10 each and pay a $0.20 annual dividend, then the dividend yield is 2%.
Dividend payout ratio is the proportion of a company’s earnings that is used to pay dividends to investors.
For example, if a company earns an estimated $1 per share and pays the same $0.20 per share, then the payout ratio is 20%.
The higher the percentage, the more likely it is that it will be reduced down the line.
Smaller ratios are less taxing on a company and reducing them has diminishing returns, so they are more likely to remain stable and sustainable.
How are Dividends Paid?
Dividends are primarily paid to investors as cash, but some companies allow for the dividend payment to be reinvested as additional partial stock in the company.
This is called a Dividend ReInvestment Plan, or DRIP.
This can be especially appealing for investors looking to maximize their returns over time rather than benefit from short term gains.
Important Dates with Regards to Dividend Payments
There are four important dates that dividend payments have:
- The declaration date
- The payment date
- The record date
- The ex-dividend date
The declaration date is simply when a company declares that it will be making dividend payments, and the payment date is when the company sends the payment out.
The record date determines a recent share-buyers eligibility to receive a dividend payment for that period.
Stock market rules say that the buyers must have purchased the share at least two days before the record date to receive payment.
The ex-dividend date is the date after which the traded share will not pay a dividend to its new owner.
After this date, the next payment will be made to the original owner.