What Are Dividends

What Are Dividends

What are dividends?

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What is a Dividend?

Dividends are a distribution of earnings or profits to shareholders. Dividends can be made in cash, stock or any other form, and they are typically scheduled at regular intervals (monthly, quarterly, or annually). There are, however, also special dividends that are paid out at irregular intervals or as a one-off. When companies earn their profits, they can decide to reinvest the money, hold the cash or pay dividends. Paying dividends is an additional reward for investors on top of potential value gains if the underlying stock prices increase. Dividend investing is very popular and ideal for investors who wish to earn regular income without selling their stock holdings. 

How Do Dividends Work?

Dividends can be paid out by both private and public companies and mutual funds and ETFs (exchange-traded funds). Before being paid out, dividends are typically approved through shareholders’ voting rights. While dividend-paying companies usually maintain a consistent schedule, dividends are never guaranteed or mandated by law. A company can hike, cut or maintain a dividend rate at will. Every share held receives a set dividend rate when a dividend is paid. 

There are different types of dividends that companies can pay out to shareholders. They include:

Cash Dividends

Cash dividends are the most popular type of dividends paid out by companies. Shareholders receive cash directly into their bank accounts for each share held. Cash dividends are typically paid regularly, but they can also be allocated on special occasions, such as when a company receives unexpected profits or sells a huge asset. Cash dividends provide shareholders with regular income, but they are also consequential for the company. They result in a permanent loss of retained earnings from the company. A company, therefore, has to balance the expectations of investors with its objectives for future growth. 

Stock Dividends

Stock dividends are an award of additional shares in a company instead of receiving cash. A company typically decides to issue bonus shares when they wish to reward shareholders, but they either have low cash reserves or do not intend to dispense their cash resources. 

When a company issues a stock dividend, shareholders receive a set number of additional shares based on their holdings. For instance, if a company issues a 10% stock dividend, investors will receive one bonus share for every ten held. Investors that desire a cash reward can proceed to sell the shares on the secondary market. 

Share dividends typically result in dilution (increased floating shares). Still, the general expectation is that the share price will continue to rise in the future and result in higher value gains. 

Dividend Reinvestment Programs (DRIPs)

Typical cash dividends deposit funds into shareholders’ bank accounts. DRIPs allow shareholders to automatically invest the dividend payment into acquiring more shares in the company. DRIPs are only available for existing shareholders (not via exchanges), and they are typically commission-free and highly discounted compared to the prevailing share price. 

DRIPs have practical advantages for both companies and shareholders. Companies benefit from having more usable capital, whereas investors receive additional shares at a bargain and in the long run, they may draw more compounded returns.

Property Dividends

Property dividends are a distribution of assets owned by a company to its shareholders. They typically come in the form of physical assets, such as real estate or shares in a company’s subsidiary. Companies issue property dividends when they do not have sufficient cash reserves and do not wish to dilute their share structure. Companies can also go for property dividends to distribute assets at fair market value instead of the book value. For investors, property dividends can be very tax efficient. They can be used to defer or lower tax liability, especially if it is an appreciating asset. 

Dividend-Paying Stocks

Stock dividends are typically paid by well-established companies with stable businesses and do not necessarily need to reinvest all their profits. Because they are generally mature companies, they use dividends to reward their shareholders instead of relying on normal growth. 

Some of the stocks that pay dividends consistently are found in industries such as oil and gas, utilities, telecommunications, banks and financial, and healthcare and pharmaceuticals. Well-established firms can generate consistent revenues and profits to guarantee sustainable dividends. 

As a highlight, over 84% of S&P 500 companies currently pay dividends. Furthermore, some companies have earned the title ‘Dividend Aristocrats.’ These are S&P 500 companies that have increased the dividend per share for at least 25 consecutive years, and they have a market capitalization of at least $3 billion. 

Dividend Aristocrats are a particular target for dividend investing strategies, and currently, around 65 S&P 500 companies meet that criterion. Examples include Coca-Cola, 3M, IBM, Caterpillar, Walmart, AT&T, and Exxon Mobil. 

Dividend stocks tend to be quality companies with solid cash flows. However, other quality companies such as Amazon, Meta, and Alphabet do not pay dividends. 

Such companies can afford to pay dividends, but they may consider that they still have a high growth ceiling which will reward their investors with higher stock price gains. Another category of growth stocks that cannot afford to pay dividends are start-ups that need cash reserves to finance their growth. 

How to Evaluate Dividends?

Here are some ratios that can help investors evaluate the quality of dividend-paying stocks:

Dividend Per Share

The dividend per share is the amount companies distribute for each share held by investors. It is important to keep track of this number to identify companies that can increase their dividends over time. A growing dividend per share shows that a company can grow its earnings over time. 

Dividend Yield

The dividend yield is the percentage paid in dividends by a company for every dollar invested in its stock. For instance, if a stock’s price is $100 and the company paid a dividend of $2 per share, the dividend yield is 2%. 

Dividend yield helps investors forecast the amount of income they can anticipate for every dividend investing dollar. As an investor, a higher yield will guarantee a healthy return on your investment, which also signifies a financially healthy company. 

That said, investors should also be wary of unusually high yields. They may be a sign that a stock’s price has tumbled drastically, or the company is trying to attract investors that will help boost the stock price. As a rule of thumb, a 2%-4% dividend yield is considered healthy, and anything above 6% should be watched carefully. 

Dividend Payout Ratio

The dividend payout ratio is the percentage of a company’s earnings that it pays out as dividends. It is calculated by dividing the total annual dividends by total annual earnings. For instance, if a company’s annual revenues are $100 million and it pays out $50 million to its investors as a dividend, the payout ratio is 50%. 

Generally, mature companies in stable industries can afford high payout ratios, whereas those in volatile industries should have low payout ratios. A dividend payout ratio of around or below 50% is considered healthy and sustainable. In contrast, a payout ratio of above 70% is deemed risky and potentially unsustainable. Dividend investors should seek to identify stocks with healthy payout ratios and not necessarily high payout ratios. 

Major Dividend Dates

To trade dividend stocks effectively, it is important to understand the following key dates:

Declaration Date

Also known as the announcement date, the declaration date is when a company’s management or board of directors announces that it will pay out dividends. The dividend announcements include the amount to be paid and an outline of the record date and payment date. 

Ex-Dividend Date

This is the date when the eligibility to earn a dividend expires. It is the first day that a stock trades without a dividend. This date is set by the relevant exchange where a stock is listed and not the company itself. 

The ex-dividend date is usually 1-3 days before the record date on many exchanges. You will be eligible for a dividend if you buy a stock before the ex-dividend date. If you buy a stock on or after the ex-dividend date, you will not qualify to receive dividend payments. 

Record Date

This is the date by which an investor must be on the company’s books to be eligible for a dividend. This date is often confused with the ex-dividend date, but they are different. The company sets the record date, whereas the relevant stock exchange sets the ex-dividend date. They are different because buying and selling stocks require a settlement period. Thus, the ex-dividend date comes before the record date. 

Payment Date

This is the date when dividend payment is made to shareholders. Dividend funds are typically mailed as checks or deposited directly into shareholders’ bank accounts. 

Dividend Stocks in CFD Trading

You do not own the underlying stocks when you trade stocks as a CFD. You only trade the stocks’ price changes. Thus, you are not eligible to receive any dividends paid out. Still, CFDs represent a great way of trading dividend stocks. You can benefit from leveraged trading and access trading opportunities in rising and falling markets

CFDs are also ideal for taking advantage of short-term price changes. There is usually volatility during dividend dates, and trading stock CFDs can help investors take advantage of these price changes. As well, dividends stocks tend to trend lower when dividends are announced and paid out because they represent the transfer of economic value from companies to investors. When trading stock CFDs, there is no restriction on short selling, and traders can plan on taking advantage of any volatility triggered by dividend dates. 

Final Words

It is crucial to understand dividends because they are vital when trading stocks. Learning how to identify quality dividend stocks can help investors potentially expand their profits and generate a healthy income stream. For short-term traders, understanding the dividend dates can help track the right trading opportunities in the equities markets. 

FAQ

  • What are dividends?

    Dividends are a distribution of a company’s earnings to its shareholders.

     
  • How do dividends work?

    Dividends are announced by a company’s management and approved by shareholders’ voting rights. They can be paid in cash, stock, DRIPs, or property.

     
  • Are stock CFDs eligible for dividends?

    No, they are not. Stock CFDs allow investors to only trade price changes of the underlying stock. They do not provide ownership.

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** Disclaimer –While due research has been undertaken to compile the above content, it remains an informational and educational piece only. None of the content provided constitutes any form of investment advice.