Investor Jargon: Dividends
A lot of investing-related language can be straight-up confusing. This can make investing seem scary and much more complex than it actually is. We’d rather investing be approachable, so we’re breaking down some of the common investing terms you might see or hear.
What are dividends?
Dividends are largely a distribution of a company’s earnings to its shareholders. They can provide a way for shareholders to receive income by holding the stock. And if you think about it, it makes sense: as a partial owner, it’s like your share of the company profits.
That said, not all companies pay dividends, and those that choose to aren’t obligated to continue paying them at the same rate or at all. Whether or not a company pays dividends is a business decision made by the Board of Directors.
Why do some companies pay dividends?
To more fully answer this question, it helps to think about what public companies can do with extra cash when they make a profit. They can reinvest in their own operations, pay down debt, or divvy it up to shareholders as dividends, among other options. Companies that are looking to grow may be more interested in putting the money to use within the business. Those not looking to grow, however, may decide dividends are the better option.
Why? Well, one reason some companies choose to pay dividends: they can be a great way to reward and retain existing shareholders, and attract new ones. Because dividend-paying stock provides shareholders with a way to generate income off of what they own, offering dividends can help increase demand for a stock. And as we know, increased demand for a stock can result in a higher price for said stock.
How much are dividends?
Your dividend amount is largely based on two factors: how much the company chooses to pay per share of stock owned, and how many shares you own. How much you actually receive as a dividend is proportional to how much stock you own in the company, aka “pro-rata” for the finance nerds out there. For example, if Totally Made Up Company issues a dividend of $0.40 per share and you own 100 shares, you’ll get $40 in dividends. The math is the same with fractional shares, too; if you have 0.25 of a share with a $0.40 per share dividend, then you’ll get $0.10.
It’s worth pointing out here that dividend rates won’t always be nice round numbers, and they can change at any time. Just because you received a dividend from a company last quarter, for example, doesn’t mean you’ll receive one the next quarter.
How are dividends paid?
Dividends are usually paid out in the form of “cash dividends”—though some companies might opt for “stock dividends” instead, and give shareholders, well, stock.
Cash dividends work just like we’ve talked about above, and it’ll usually end up as a balance in your brokerage account.
Stock dividends, on the other hand, increase your number of shares in the company. So if a company had a 5% stock dividend, for instance, and you had 100 shares, you’d get 5 additional shares of stock in the company.
It may also be possible to reinvest any cash dividends you receive back into the same stock (it’s called dividend reinvestment). That’s how Bumped handles dividends: whenever possible, we’ll try to reinvest them into more of the same company’s stock. Read more in our support article.
When are dividends paid?
Dividends typically happen on a quarterly basis and there are a few dates you’ll need to be aware of as a shareholder. When a company decides they’re going to issue a dividend, they’ll declare the record date, which is the date you need to own shares on in order to receive a dividend. That said, the real date you’ll want to keep track of is the ex-dividend date. This is set by stock exchanges and is usually one business day before the record date. If you purchase stock on or after the ex-dividend date, you won’t get the dividend.
The third and most fun date to keep in mind: the payable date. That’s when you’ll actually get your dividend if you’re eligible for one.
Can dividends affect stock price?
Yep. Say, for example, Totally Made Up Company has a market price of $100 per share and they pay a dividend of $2.50 per share. On the ex-dividend date, the stock’s market price will decrease by the per-share dividend amount—making it $97.50, assuming no other price fluctuations. That’s because the ex-dividend date is the first day shares of Totally Made Up Company stock can be purchased without the right to this specific dividend (hence the name “ex-dividend”). Folks buying the stock on or after that date don’t have a claim to the dividend, so the price decreases to reflect that change.