The main value of a stock is usually the share price, which you pay when you buy it and receive when you sell. But there may also be another source of income when you hold stocks and some other investments: dividends. Dividends are your share of a company’s annual profits.
What Are Dividends?
Dividends are regular payments of cash that shareholders receive on a per-share basis. So if a company pays $1 in annual dividends, and you have 50 shares of stock, you will receive $50 each year. Companies may pay a fraction monthly, quarterly, or semiannually.
Not all companies pay dividends. Each year, the board of a company decides whether or not to pay dividends. Younger companies generally don’t, because they reinvest their profits back into the company. Large, established companies often do. Companies prefer to keep their dividends the same or increase them because when dividends fall, investors often sell the stock, causing a price drop. Companies that have increased their dividends every year for the past 25 years are called dividend aristocrats.
Receiving dividends is a taxable event, which makes dividend-paying stocks undesirable for some investors. If you have held a US-based or US-traded stock for at least 60 days, you can report the income as capital gains for a lower tax rate. If not, dividends will be taxed as regular income.
Types of Dividends
Not all dividends are the same. The most basic type is cash dividends, where you are simply paid cash on every share you own. But there are other types as well:
- Stock dividends, where you are paid in more stock
- DRIPs, or dividend reinvestment programs, where you can opt to receive either cash or more stock
- Special dividends, a one-time extra payment when the company has extra profits
- Preferred dividends, when only holders of preferred stock receive dividends
- Fund dividends, dividends distributed by a mutual fund. These may come from the interest on its bond holdings or from dividends on its various stock holdings.
One advantage of stock dividends and DRIPs is that they do not create a taxable event. You can keep the stock you earn this way until it’s convenient to you to realize your capital gains.
Measuring Dividends
When a dividend is announced, it’s important to take note of the ex-dividend date, or ex-date. This is the date you have to own the stock by to receive the dividend. If you sell the stock after the ex-date, you will still receive the dividend. Stock price may fluctuate some in advance of the ex-date as people factor the dividend they will receive into their valuation of the stock.
Another important thing to know is the dividend per share over time. Has the company reliably distributed the same amount or more per share, year after year? That’s a company that will likely pay the same dividends next year too.
A still more useful measure is the dividend yield. This divides the dividend per share by the share price. So a stock trading at $100 and paying $10 annual dividends has a dividend yield of 10%. Meanwhile a security trading at $10 per share and paying $1 annual dividends has the same dividend yield, 10%. After all, for the same amount of money invested, you would receive the same amount in dividends. You would just have a different number of shares.
Do You Want Your Stocks to Pay Dividends?
Not everyone wants dividends! You may prefer to invest your money in a fast-growing company, watch the share price increase, and sell it when you want. This prevents unexpected taxes. On the other hand, you may like the idea of an ongoing income without selling the stock. In that case, you’d choose stocks that predictably pay dividends.
Ask your financial advisor if dividends will be a net positive or negative in your investing strategy. They can also direct you to good stocks that pay reliable dividends. To meet the right advisor for you, contact us today.
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