Dividend

A dividend is a form of distributing a company's profits to its shareholders, usually on a quarterly basis. The amount of dividends paid is established by a decision of the board of directors of this company. Dividends can be paid in cash or even reinvested in additional stock. The dividend yield is the annual dividend payout to shareholders, expressed as a percentage. This indicator tells the investor about the amount of expected income that he can receive in the future from a particular stock, taking into account the current price and under the condition that dividends remain at the same level.

Dividend explanation

A dividend is a remuneration that is paid to shareholders from the net profit for their investment in the company's capital. According to the decision of some companies owners, part of the profit can be used to pay dividends, and not be reinvested, that is, remain within the company for the subsequent development and expansion of the business. Dividends are approved by voting rights shareholders, in addition, dividends can be received from mutual funds as well as from ETFs. In some cases, when a company does not make sufficient profits, it may continue to pay dividends in order to maintain firm loyalty.

Companies such as Microsoft (MSFT) and Apple (AAPL) regularly pay dividends quarterly, but the frequency of such payouts can also be monthly or annual. Payout rates are set individually by the board of directors of a particular company and can be revised based on profit received for a certain period of time. 

It is also worth mentioning the existence of special dividends, which are unscheduled, unpredictable one-time cash rewards companies pay to their shareholders. For example, on the back of strong FY 2020 results and strong monthly sales growth, Costco Wholesale's board of directors announced a decision to award shareholders a special dividend of $10 per share.

Who pays Dividends

The best dividend payer is considered to be a large, established company with a stable income, most often related to the following sectors of the economy:

• Industrials
• Healthcare
• Utilities
• Financials
• Materials

Nowadays, in sectors such as technology and biotechnology, there are many start-ups that require the direction of cash flows in the form of profits for the development and expansion of business and various research, which is why these sectors most often do not involve the payment of dividends.

Dividend dates

For US dividend-paying public companies, the following dates are relevant:

Announcement date. This is the day the company announces dividends. It should be noted that before the payment moment, dividends must be approved by the shareholders of the company. In addition, on the announcement date, the company can also disclose important details of a decision that may have one or the other influence on the business in the future.

Ex-dividend date. The ex-dividend date (the ex-date) determines whether the owner of the share has the right to receive upcoming dividends. An investor would not be included in the register of shareholders with the right to receive payments if his purchase was made on the ex-date or before it. If the investor wants to receive dividends, but long-term ownership of this company’s securities is not included in his plans, then he can sell the shares on that date.

Record date. The day on which the list of all shareholders of the issuer is recorded (often called cut-off date). It is noteworthy that the period during which the trader owns shares does not affect payments: securities can be bought both a few months and a few days before the record date for dividends.

Payment date. The date implies the transfer of the due income to the shareholder’s account. Most often this happens within a month from the cutoff date. Thus, the payment date is the actual day the dividend is paid.

Dividend effect on share price

One of the investment tactics is to buy certain securities at a certain time in order to receive dividends. Buying securities before the ex-date and selling them immediately after the record date can lead to a net profit, provided that all conditions are strictly observed. Thus, on the announcement date, the price may increase by the amount of declared dividends, however, on the ex-date and later, the price may decrease by approximately the same amount.

Another example. Assume that a company declares a high dividend for the past year that is twice its expected amount. At this point, this security’s dividend yield starts to rise and eventually reaches 10%. After that, the share price rises sharply to match the company's dividend yield with its competitors in the same country and industry. Most likely, this stock will not double in price, but it will definitely increase.

Reasons for paying dividends

A dividend is an important component for any investor, especially for a long-term one. The dividend payout maintains his confidence in the company. Dividends are regarded by shareholders as a reward for their investment in a company. A company that constantly pays dividends and tries to increase them every year is valued in investor circles. 

On the one hand, the payment of high dividends by the company gives a signal to investors that the company is profitable and that it is doing well. On the other hand, this may also indicate the absence of long-term projects that involve greater profits in the future. This is why cash is used to pay dividends to shareholders rather than being reinvested in growth.

If a company informs its shareholders about the reduction of dividend payments or even the refusal of them, but all the while it has always been a stable dividend payer, this may signal a deterioration in business and the presence of problems in this company. As a rule, a reduction in dividends is followed by a fall in the value of a company's shares. 

Choice of Dividend-paying investments 

There are several options for investors to receive dividends: stocks, mutual funds, and exchange-traded funds (ETFs). The dividend discount model or the Gordon growth model can be useful tools when choosing to invest in stocks. These methods are based on future dividend flows to value stocks.

The dividend yield ratio, which measures dividends as a percentage of the current market price of a company's shares, allows an investor to analyze several stocks in terms of dividend payout efficiency.

The total return ratio is another important indicator for evaluating the returns generated from specific investments. This figure includes interest, dividends and share price growth, as well as other capital gains.

When choosing dividend securities, taxation also should be taken into account. The lower the tax, the better for the investor. Some countries do not tax dividend income at all.