What is a dividend?

Understanding a dividend

For stock investors, their returns generally come from two sources. One is capital gains, realised through the sale of a share with an increased price. For example, if you buy a stock at $100 per share and sell it at $110, the capital gains will be $10 ($110-$100) per share. The other is dividends. Typically, dividends are paid out on a company’s common stock in cash. Regular dividend payments make a company more attractive to investors because they generally showcase the company's robust financial position.

Mature companies are more likely to pay a dividend because they require less capital as opposed to young, high-growth companies who prefer to reinvest most of their profits to sustain future expansion.

Typically, dividends are paid out on a company’s common stock in cash. Regular dividend payments make a company more attractive to investors because they generally showcase the company's robust financial position.

In the United States, companies usually pay dividends quarterly. The board of directors decides on when to declare a dividend payout and the amount of the payment. For investors, there are four important dates regarding dividends: the declaration date, the record date, the ex-dividend date, and the payment date.

• Declaration date — This is the date on which the dividend is declared by the company. It usually accompanies the company’s earnings release.

• Record date — Record date is set as the company declares a dividend. It means that shareholders on record on that date are entitled to the dividend payment.

• Ex-dividend date — This is the date on which a stock begins trading ex-dividend. It precedes the record date because the settlement of stock purchases takes time. If you buy shares on or after the ex-dividend date, you are not qualified to get the dividend.

• Payment date — This is the day when the dividend is credited to shareholders' respective accounts.

When stocks pay dividends, that payout is taxable. So the dividend you should receive in your brokerage account will be after-tax.

How dividends affect the share price

Dividends affect the share price in several ways. However, it is worth noting that dividends do not increase shareholder wealth or market capitalisation. As a dividend payment leads to cash going out of the company, the share price often drops by a similar amount to the dividend on the ex-dividend date.

Dividends affect the share price in several ways — but it is worth noting that dividends do not increase shareholder wealth or market capitalisation.

For example, a company announces a dividend of $2 per share on the declared date. If its stock trades at $100 per share a business day prior to the ex-dividend date, it will likely be adjusted by $2 and begins trading at $98 per share on the ex-dividend date.

Though dividends are not guaranteed to shareholders, many established companies pursue a prudent dividend policy. That's because if a company announces a lower dividend, it may indicate the company is short of cash or its business operation is getting worse, which could affect the share price. Conversely, a higher dividend may signal that the company has become more profitable and investors can expect a higher stock price.

Key Takeaways

• A dividend is a distribution of some company's profits to its shareholders.

• Matured companies are more likely to pay dividends, while growth companies prefer to reinvest most of their profits for business expansion.

• There are four important dates regarding dividend payments, among which the ex-dividend date is crucial for investors who trade the stock.

• A dividend may move the share price up or down in the short run, though it does not increase shareholder wealth or market capitalization.

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