What Are Dividends? (and Why You Need Some)

By Charles Joseph | Editor

If you’re thinking of investing for the first time, congratulations! Now that you’ve made this decision, you’ll likely encounter many new terms and concepts, like “dividend.” No worries, we’re here to help!

So, what is a dividend? Think of a dividend as the way a company thanks you for being a part-owner — that is, when you buy shares of its stock. The company is, in effect, sharing its profits with all of its stockholders.

And if you buy enough shares that provide dividends, you can literally get paid just for holding them. In fact, many retirees do just this — they retire, buy their dream RV, and blissfully travel for the remainder of their days with a steady paycheck in hand.

Let’s discuss more of this.

What Is Company Stock?

Publicly traded companies offer shares of themselves to just about anyone who wishes to buy them. Investors (that’s you!) can choose to buy a little or a lot.

Whether you choose to buy one share or 1,000 shares, you are an official stockholder as soon as you make a purchase. Congratulations, you’re now part-owner of a company!

There are many different trading platforms or places that help you invest. A few of the bigger platforms are Fidelity, TD Ameritrade, and Charles Schwab, to name a few. You can choose a smartphone app or a personal stockbroker to get started.

Some apps and personal investment plans offer fractional shares. This means that you can invest smaller amounts of money and build your way up to full shares as you invest over time.

While fractional or partial shares are a great way to start investing in companies with high share prices, they may not be eligible for stock dividend payments. More on that later.

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Stock Dividends

Simply put, dividends are small payments made to stockholders. This is one-way companies show their appreciation for people who own shares of the corporation.

There is just so much we could say about stock dividends! For now, we’ll stick to a few basic but key points:

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  1. Profitable companies may pay dividends
  2. Not every profitable company pays dividends
  3. Dividend payments are paid on each share of stock
  4. There are different classes of stock
  5. Companies pay stock dividends at regular intervals
  6. There are some restrictions on dividend payments

Publicly traded companies issue several reports throughout the year. These reports may be monthly but are usually released at least quarterly. Most companies also have one comprehensive annual report.

Company-reports outline, among other key data, how profitable a company has been during the review period. This is important news to investors because a portion of the profits are used to pay stock dividends.

Do Companies Have to Pay Stock Dividends?

Some large, profitable companies choose not to pay dividends to shareholders. This isn’t a good or bad decision for the company or the shareholder.

Corporations that don’t pay stock dividends are probably reinvesting profits into other things. Research and development projects, as well as capital expansion reviews, help the company grow and earn more profits.

It’s important to note that companies aren’t required to share profits with the public or offer stock dividends. However, when a corporation announces it’ll pay dividends, the company must release them to shareholders.

There are two dates associated with stock dividends:

1. The record date is when the company pulls records to get the names of all the eligible shareholders. You must own the stock before the close of business on this day to receive a dividend payment.

2. The ex-dividend date is usually a day or so before the record date. If you purchase on or after the ex-dividend date, you won’t be eligible for the stock dividend payment.

These dates are slightly different for each company, but they are openly published. You should not have trouble finding these specific dates and know when to buy or sell shares if you are hoping to yield a dividend payment.

Remember that some corporations release different classes of shares of their company stock. A company defines the various classes of stock it offers entirely as it sees fit so it isn’t something we can define here, but generally speaking, each class of stock is differentiated by voting rights.

In other words, one class could be for high-level executives and yield more voting power, while another class would be common stock and sold on a stock exchange. These usually have similar ticker symbols and may use an A or B, or some other character to set them apart.

The share price of these different classes will vary, and some classes may not be eligible for dividend payments. This situation is not too common, but it’s something to be aware of when making investment choices.

What Happens to the Stock Dividend Payment?

Stock dividends can be paid directly to the shareholder or reinvested back into the company stock, a decision the shareholder makes.

Some investors have several dividend-yielding stocks in their portfolio. They expect to receive regular dividend income payments throughout the year, which comes in the form of a check or an electronic funds transfer.

Reinvested dividends are still beneficial to the shareholder, even though they do not receive the payment in hand. Stock dividends reinvested into the company stock result in additional shares of stock ownership for the investor.

For example, assume you own five shares of stock that are worth $10 each. Pretend that the stock price does not change, so your total investment for this stock is $50.

If a company pays a stock dividend of .25 per share, your total dividend payment equals $1.25 for all five shares. Make sense so far?

Now, you could either receive the $1.25 by check and buy yourself a soda or reinvest the stock dividend and go for a walk instead.

If you reinvest the dividends, your total investment for the stock increases from $50 to $51.25. We used simple math here, but can you see how accumulating stock-shares through dividends could add up over time?

Stock dividends paid directly to the shareholder may be considered taxable income. Check with a tax advisor if you are unsure how stock dividend payments will affect your tax situation.

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Final Steps

Stock dividend payments can help you build your portfolio or supplement your income. You can choose to add them into your investment mix by selecting companies that historically pay dividends to shareholders.

Hopefully, this brief overview of dividends answered your questions about stock dividend payments and transactions.

Luckily, technology is literally at our fingertips today. Most investment sites and smartphone apps walk you through the stock dividend process step-by-step.

When you purchase shares of a stock that is likely to pay dividends, you’ll be required to provide certain information. This typically includes your payment method preference and contact information.

Keep in mind that you can change your selections over time. You may reinvest your dividends back into the company stock for several years, then decide you want to have them paid to you instead. These changes are pretty simple to make.

As you increase your investment portfolio and begin to make new stock selections, consider your options. Do you prefer to invest in companies that may present a higher risk but are likely to experience growth over the next five years?

Choose an investment platform that offers additional information on your investment options. Learning about the corporations you would like to invest in will help you sort out your investment goals.

Perhaps you do want to invest in companies that are expected to grow rapidly, and you’re hoping their stock price will continue to rise sharply over the next few years.

Maybe you employ a more conservative investment style and prefer to fill your portfolio with stable companies that are household names. You will probably find that many of these companies do pay dividends.

Again, there is no right or wrong way to choose your company stock selections. You’ll find your own best mix over time. Good luck and keep learning!

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