What is dividends

What is dividends?

Dividends are payments made by a company to owners of the company’s stock. They are a way for companies to distribute revenue back to investors, and one of the ways investors earn a return from investing in stock.

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What precisely is a dividend?

A dividend, to be more specific, is a payment made by a corporation to its shareholders. These payments are usually made by using the company’s profits. This distribution of funds may be either in cash or any other form which will be discussed below. Let’s take a company such as Coca Cola for example. If they reach a profit surplus, they can choose to reinvest some of this money back into the organisation and also pay their shareholders a portion of this profits which is then called dividends.

At current times there are 4 popular dividend types, these are:

1 – Cash dividends

These types of dividends are the most common to date. A certain dividend amount is paid out in cash to investors holding stock in the company. These pay-outs occur on specific dates chosen by the company’s board of directors and their size are in relation to the percentage stock each investor owns. Long term investors can reinvest their cash dividends to increase their share in the company.

Cash dividends are a basic way for companies to return capital back to their shareholders. Note that the payment period can be monthly, annually or any other time period chosen by the board of directors.

A company which offers cash dividend pay-outs are usually stable companies which are far beyond their start-up stages.

2 – Stock dividends

These types of dividends are made in the form of provision of additional shares, rather than cash, to investors. These types of dividends are usually paid out when a company has a short supply of liquid cash or when requested/agreed upon by the investor(s).

The amount of stock dividends paid out to an investor are usually paid out in relation to the amount of stock that investor already holds. The more share an investor holds, the more additional share they receive with stock dividend pay-outs.

Stock dividends are also known as scrip dividends and have major tax advantages as these dividends are not taxed until they are sold by the individual investors although if a cash dividend option is available then tax will be taken either way.

There are 2 types of stock dividends: Small Stock Dividends, which are stock dividends that are the size 25% or less of the total outstanding dividend and Large Stock Dividends 25% and more.

3 – Property dividends

These types of dividends can include one of two options: A share/stock of a subsidiary company, or a physical asset owned by the company for example real estate, inventory etc.

Once these dividends are assigned, their price are recorded at market value of the linked asset. The investor may choose to sell the asset or hold on to it.

This is a very unpopular dividend and is usually only chosen if the company either does not want to dilute its current share position or does not have enough cash on hand to distribute payments.

These types of dividends can be very advantageous to investors as no tax is paid on them unless they are sold. The investor can thus hold on to the dividend and hope for further growth in the future.

4 – Liquidating dividends

This type of dividend is the last type of dividend we are discussing for the purpose of this article. These dividends are payments which are made by a corporation to their shareholders during a liquidation, partially or fully. These dividends are usually not taxable to shareholders as they are seen as return of capital.

A disadvantage of these dividends occurs when a shareholder’s supporting company has deteriorated in their quality, thus leading to the liquidation amount not covering the shareholder’s initial investment.

These types of dividends usually do not have a pay-out date. Liquidation only occurs when a company is insolvent or when its operations end.

Stocks that pay dividends

Stocks that pay dividends can provide a stable and growing income stream. Investors typically prefer to invest in companies that offer dividends that increase year after year, which helps outpace inflation.

Dividends are more likely to be paid by well-established companies that no longer need to reinvest as much money back into their business. High-growth, tech or biotech companies rarely pay dividends, because they need to reinvest profits into expanding that growth.

Once a company establishes or raises a dividend, investors expect it to be maintained, even in tough times. The most reliable American companies have a record of growing dividends — with no cuts — for decades. Investors often will devalue a stock if they think the dividend will be reduced, which lowers the share price.

Examples of companies that pay dividends include Target, Apple, CVS, Disney, Exxon, Bed Bath & Beyond and PepsiCo.

Top 5 dividend-paying companies

Here is a short rundown of the top 5 dividend-paying stock as of 2019:

  1. The Carlyle Group (CQ). With a market cap of $10.9 billion, a dividend yield of 4.3% was obtained with a 117% return in 2019.
  2. Apollo Global Management (APO). With a market cap of $19.2 billion, a dividend yield of 4.2% was obtained with a 107% return in 2019.
  3. The Blackstone Group (BX). With a market cap of $67 billion, a dividend yield of 3.5% was obtained with a 96.3% return in 2019.
  4. Western Digital (WDC). With a market cap of $18.9 billion, a dividend yield of 3.1% was obtained with a 77.1% return in 2019.
  5. Seagate Technology (STX). With a market cap of $15.3 billion, a dividend yield of 4.3% was obtained with a 409% return in 2019. Although Seagate has a higher dividend yield than some above it, this is not the only factor to keep into account for these rankings.

Pros and cons of dividends

Pros

  1. Shareholders receive money for holding a share of stock in a company.
  2. While companies do sometimes reduce their dividend pay-out, one will find that on average companies raise this pay-out which in turns gives an extra bonus to investors.
  3. Dividends can be reinvested creating a massive exponential growth return each year.
  4. At this moment in time, dividends are less tax demanding than bonds or an ordinary income.

Cons

  1. It is found that on average, dividend-paying companies, see less price appreciation than growth stocks.
  2. The share prices can drop right before a dividend pay-out.
  3. Companies have the right to eliminate their dividend pay-outs at any time for any reason.
  4. Tax rates on dividends may rise in the future which in turn makes dividend stocks the less attractive option.

So why does some companies not offer dividends

There are many reasons companies may decide to not pay out dividends or even stop paying dividends. A few reasons are listed below.

If a company does not have a very liquid financial situation and needs as much cash on hand as they possibly can, they will most likely not pay any dividends to shareholders.

If a company does not reach or breach their profit goals, they are also most likely not going to pay out dividends.

And the last reason we will list is that some firms avoid paying dividends due to the cost of raising external funds.

Conclusion:

Now that the definition of a dividend is covered and a brief overview of the four main dividend types were discussed. You as reader hopefully has a better understanding on this topic which could benefit you if you find yourself in a situation where one of these options can become a possibility. The question to find the best option that suits your current situation is hopefully made a slight bit easier.

For more information on dividends, visit our contact page and a starttrading.com mentor will contact you.

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