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What is a Dividend?

Jack and Nick Author Pic
Jack Kramer & Nick MartellJuly 2, 2019
Forbes 30 Under 30 in media, appeared on CBS, Cheddar. Registered representatives of Robinhood Financial LLC.
definition

Stock dividends are a quarterly payment from a company’s profits distributed to its shareholders.

This graphic illustrates the concept of a company earning profits that sends some portion of them to shareholders as cash dividend.

🤔 Understanding dividends

Investors in stocks earn returns primarily in two ways: dividends and stock price increases. Dividends are when a company returns a portion of its profits to shareholders, usually quarterly. Dividends go predominantly to shareholders, since they’re the owners of the company, and they tend to be issued in cash. Companies don’t ​need​ to pay dividends — they could invest profits back into the company instead by, for example, hiring employees. Dividends are typically paid by mature companies, not earlier stage ones.

example

Power utility firms are often mature companies with relatively steady profits that tend to pay shareholders dividends. Whereas younger tech companies tend to focus heavily in growth, so they may prefer to invest profits back into themselves. For example, Pacific Gas & Electric paid a dividend of $0.490 per share in the 1st quarter of 2017, while GoPro has never paid one as of the 2nd quarter of 2019.

Takeaway

A dividend can feel like a birthday check from grandma…

Except it’s sent by the company whose dividend-paying stock you might own. And they may distribute it a few times per year — or, if the company doesn’t pay dividends, not at all.

Tell me more...

What is a dividend?
How dividends work for an investor
Dividend paying companies
Important dates linked with dividends
Impact of dividends on share price
Why companies pay dividends
Are dividends irrelevant?
Interest in dividend-paying investments

What is a dividend?

As a shareholder of a company, you’re a part owner, and may receive a proportional ownership piece of profits. Dividends are how companies can directly reward shareholders with primarily cash payments, and they’re one of the primary ways stockholders generate an investment return.

But companies don’t have to hand out dividends — they’re distributed at the company’s discretion. And companies may change the frequency and amount of their dividend payouts. Early-stage and growth companies typically don’t distribute dividends, instead reinvesting profits into their own growth, like building new factories or hiring more researchers.

In order for a company to pay a dividend to shareholders, it must be approved by the board of directors. This Jedi Counsel (i.e, board of directors) is made up of advisors to the company selected to represent the shareholders’ interests. The timing of the dividend is decided by the company’s management — whether or not it happens is the board’s call.

How dividends work for an investor

Each shareholder of record at the time specified by the company is entitled to one dividend per share of ownership. Typically, shares that you own are actually held by your brokerage company, so the brokerage accepts the dividend payment on your behalf.

Dividend paying companies

Age can make a difference. Young companies typically spend their money differently than older ones do because they usually have different priorities. Dividends are a fantastic reflection of that. Younger companies may still be in a growth phase, so they tend not to pay dividends in order to maximize the money they have to spend on growth. More mature companies, whose biggest periods of growth are probably behind them, are more likely to pay dividends.

Growth stocks: When companies have growth opportunities, it may make more sense to re-invest profits in growth than to pay profits to shareholders as dividends. For example, if a company just created a great software program, the short-term goal may be to get as many clients as possible using it, so it might invest profits in more salespeople instead of paying shareholders dividends.

Mature stocks: When companies have scaled to dominate their own market and days of rapid growth are in the past, they are more likely to reward shareholders with dividends instead of investing in more growth.

No matter the company age or size, its leaders must decide what’s better for shareholders: paying dividends, investing in growth, or paying down debt. The answer depends on many factors, and a critical one of them is where the company lies in its growth cycle.

Important dates linked with dividends

Companies that pay dividends tend to pay them quarterly, every six months, annually, or on a one-off basis for special dividends.

Want to receive the dividend? Make sure you’re a shareholder on the right date — the record date. Here’s the schedule to know:

  • Declaration Date: Think of this like you would a “Save The Date” announcement for a wedding. It’s a statement announced by the board of directors about a dividends’s amount, date of record, and payment date.
  • Ex Dividend Date: Circle this date on the calendar. If you haven’t bought the stock by this date, you will not receive the dividend. You’ll have to wait until the next dividend is declared. Since settlement of stock purchases typically takes two days, the Ex Dividend Date is the day before the record date. You must buy shares prior to the Ex Dividend Date to get the dividend.
  • Record Date: This is the date on which you need to be a shareholder to get the dividend that was declared. There’s usually a delay between your order to buy a stock and when you become an official shareholder (it typically takes two days), so make sure to show up early, like you would at the airport.
  • Payment Date: This is when money (or shares) will be paid to shareholders eligible for the dividend (registered shareholders on the Record Date). Depending on the instructions you left with your brokerage account, the money will either show up as cash in your account or will be reinvested in more shares (or partial shares) of the company that issued the dividend. Robinhood Financial LLC does not have a dividend reinvestment program.

Impact of dividends on share price

Dividends can send important signals to the market about how well the company is doing. That means dividend decisions can move a stock’s price up or down.

  • How dividends can boost the stock price: “Bagel Friday” makes the office more fun. Dividends can do a similar thing for shareholders. They’re a celebration of a company’s sustained profits, and a reward to shareholders for investing in the company. If a company announces new or increased dividends, it can make the stock more attractive to investors and increase the share price. If you’re a long-term investor who’s seeking reliable income from stocks, dividends can be particularly attractive.
  • How dividends can hurt the stock price: If a company announces a cut to the dividend, it’s a possible sign that the business is struggling. Companies typically only offer dividends if they’re confident they can maintain their dividend rate, which can rely in part on consistent profits, because they want to avoid the negative signal that comes with cutting a dividend.

Why companies pay dividends

For a company to issue a dividend, it usually is profitable (or at least has a history of profits). Companies have three primary things they can do with their profits:

Reasons_desktop
This graphic illustrates some common ways that a company earning profits could make use of those profits.

The company’s management must decide how to handle its profits. Dividends can be a good option for companies when they believe it’s in the best interest of shareholders. Receiving cash payments is a clear benefit for shareholders, but it’s not necessarily the most beneficial option. If a company has a high debt level, paying dividends could cause some operational issues, ultimately hurting the stock price. If a company has a big growth opportunity, shareholders may prefer it invests in that opportunity instead, like building more stores.

Are dividends irrelevant?

No. They’re not. The ability to issue dividends to shareholders is generally a long-term goal of any company. Dividends are a key way that companies share their success with shareholders.

Stock prices can still rise without there being dividends. But one reason stock prices increase is the expectation of future profits. And eventually, future profits can turn into dividends.

Interest in dividend-paying investments

The dividend yield is the percent of the share price that gets paid in dividends annually. This metric is often compared to a bond’s coupon rate because both measure the amount of cash income that investors receive.

Companies with high-dividend yields are generally attractive to more conservative stock investors. Stocks with low or zero dividend yield are either unprofitable or are investing profits in something else. These are usually categorized as growth stocks, and may have different investment merits than stocks that offer dividends.

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This information is provided for educational purposes only and is not and should not be construed as an offer to sell or a solicitation of an offer to buy any security. In addition, this information is not intended to serve as a recommendation to buy or sell any security or other investment product. This information is not individualized, does not constitute a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security, or financial product does not guarantee future results or returns. Before making decisions with legal, tax, or accounting ramifications, you should consult appropriate professionals and/or an investment adviser for advice that is specific to your situation. Securities offered through Robinhood Financial LLC, member FINRA/SIPC. The information used to create this content is based upon information reasonably available to Robinhood Financial LLC as of the date of publication.