Dividends definition

Dividends are a portion of a company's earnings which it returns to investors, usually as a cash payment. The company has a choice of returning some portion of its earnings to investors as dividends, or of retaining the cash to fund internal development projects or acquisitions. A more mature company that does not need its cash reserves to fund additional growth is the most likely to issue dividends to its investors. Conversely, a rapidly-growing company requires all of its cash reserves (and probably more, in the form of debt) to fund its operations, and so is unlikely to issue a dividend.

Dividends may be required under the terms of a preferred stock agreement that specifies a certain dividend payment at regular intervals. However, a company is not obligated to issue dividends to the holders of its common stock.

Those companies issuing dividends generally do so on an ongoing basis, which tends to attract investors who seek a stable form of income over a long period of time. Conversely, a dividend tends to keep growth-oriented investors from buying a company's stock, since they want the firm to re-invest all cash in the business, which presumably will jump-start earnings and lead to a higher stock price.

There are several key dates associated with dividends, which are:

  • Declaration date. This is the date on which a company's board of directors sets the amount and payment date of a dividend. Note: Only the board of directors can approve the issuance of dividends.

  • Record date. This is the date on which the company compiles the list of investors who will be paid a dividend. You must be a stockholder on this date in order to be paid.

  • Payment date. This is the date on which the company pays the dividend to its investors.

A number of publicly held companies offer dividend reinvestment plans, under which investors can reinvest their dividends back into the company by purchasing additional shares, usually at a discount from the market price on the reinvestment date, and without any brokerage fees. This approach allows a company to maximize its cash reserves, while also providing an incentive for investors to continue holding company stock.

Dividends may also be paid in the form of other assets or additional stock.

Once a dividend is paid, the company is worth less, since it has just paid out part of its cash reserves. This means that the price of the stock should fall immediately after dividends have been paid. This may not be the case if the proportion of total assets paid out as a dividend is small.

The dividend payout ratio is the percentage of a company's earnings paid out to its shareholders in the form of dividends. The dividend yield ratio shows the amount of dividends that a company pays to its investors in comparison to the market price of its stock. These ratios are closely watched by investors.

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