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What are dividends and how do they work

By The Loved Investing Team November 08, 2020

What are dividends and how do they work

Dividends are a really cool thing to receive because they're a reward for having invested in a company that makes a profit.

Many investors look to companies that pay dividends as they can provide a regular stream of income. However, not all companies pay dividends so many investors bear that mind when looking for companies to invest in.

How does it work?

If you have 100 shares of stock XYZ and it pays a $1 annual dividend, you will receive $100 in a dividend payment each year. Typically, this payment is given in cash and distributed directly to your brokerage account. However, a company may instead allow you to use your dividends to reinvest in the stock at a discounted price or simply pay you dividends with new shares of stock.

Whatever it may be, it is a reward for staying invested in a company.

How often are dividends paid?

Companies typically pay quarterly dividends, but some pay them monthly or semi-annually; it is ultimately decided by the company's board of directors. Before a company pays their dividend, they release other information in advance such as the amount of the dividend and when will it be paid. They must also determine who is eligible to receive the dividend by establishing an ex-dividend date. If you purchase stock in a company before the ex-dividend date, you will receive that dividend. If you purchase the stock on or after that date, you must wait until the next round of dividends to receive your share!

Fun fact: If you bought shares in a company before the ex-dividend date and sold them after the ex-dividend date, you will still receive your dividend as you had purchased the shares prior to the ex-dividend date.

Why don't all companies pay dividends?

Companies are not required to pay dividends and may instead reinvest profits back into the company in hopes it will grow in the future.

For example, fast growing companies like Amazon and Google are more focused on expansion into new markets and instead of paying dividends, they use those profits to finance such moves. This is typically reflected in a rise in stock prices and an increase in your wealth as a shareholder!

Companies that pay dividends can provide a more stable income stream and for you as an investor, this is something you should factor into account when deciding on where to invest.

Are all dividends the same?

There are actually three types: common dividend, preferred dividend, and a special dividend.

Common Dividends – This is the dividend paid to common shareholders (like you and me) who invest through a brokerage. As mentioned above, your common dividend can be dispersed through cash or stock.

Preferred Dividend – If you are a preferred shareholder, you receive a preferred dividend. This means you have priority over common shareholders and if a company is struggling to pay out all dividends, you will get paid first. The main benefits are higher dividend payouts and security of dividend rights.

Special Dividend – This is a dividend that is separate to the traditional dividend a company might already pay and is paid separately in a once-off event. Companies usually do this when they have extra-strong earnings or the sale of an asset and want to distribute the profits to shareholders.

Anything else I should know?

There are several ways to analyze how a company’s dividend structure compares to another and Dividend Yield is one of the best ways to to understand return relative to the price of a stock.

For example, a $50 stock paying a $1 dividend gives a dividend yield of 2% in the same way a $100 stock paying a $2 dividend returns a 2% dividend yield. A dividend yield help understand the return you are making on your money given the price of the stock.

With information like this you can make more informed investing decisions to grow your account!

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