What are Dividends?
When it comes to earning profits, listed companies have a few options.
Repurchase some of their shares on the stock market
reinvest their money to aid in growing the business
What are Dividends? Of its to shareholders in the form of dividends
How often dividends are distributed largely depends on the announcement of the company's profits - usually annually, semi-annually or quarterly.
Nevertheless, companies are able to distribute dividends whenever they want. For instance, significant cash flows into a business, or a sale of a subsidiary may lead to a company's declaration of an additional dividend.
Types of Dividends
Generally speaking, we only talk about two types of dividends:
Stock: Companies can opt to distribute additional shares to their investors as a dividend. This form of dividend is known as a "scrip dividend", and these are quoted either as a percentage, or on a per-share basis. If a company chooses to distribute a 5% (or 0.05-per-share) dividend, shareholders will receive an extra share for every 20 that they own
Cash: These are typically quoted on a per-share basis, and are paid out of a company's earnings. To illustrate, if a company announces a $0.25-per-share dividend, and you have 500 shares, you will receive a dividend of $125.
Why do Companies Distribute Dividends?
Through the distribution of dividends, companies are able to share their profits with their shareholders as a form of gratitude for their ongoing support. Through providing them higher returns, companies are also able to encourage investors to hold onto their stocks.
Investors see consistent dividends as a marker of a company's stability. Consistent dividends also demonstrate that the company is likely to continue growing in the future. In other words, dividends are a way to attract investors to invest in a company, allowing the company to raise its stock prices.
There is a higher chance that potential investors will select companies that have a past record of attractive dividends, especially if these potential investors are relying on constant dividend payments to support their lifestyles.
Why do Some Companies Choose Not to Distribute Dividends?
Generally speaking, bigger and better-established companies are more likely to distribute dividends compared to smaller firms and start-ups.
Nevertheless, it cannot be said for certain that a company will distribute dividends. Companies that have distributed attractive dividends in the past may choose to stop as and when they wish to. A halt in dividends could be due to a company's plans for acquisition, or other investments that call for high amounts of cash.
Dividend Yield - What does It Mean?
While considering the potential income return from a stock, investors tend to check a company's dividend yield.
For instance, if Company X's stocks are trading at $100 and the company is distributing a yearly dividend of $4 per share, then that company's dividend yield is 4% ($4 ÷ $100 x 100).
In contrast, if another company, Company Y's stocks are trading at $500 and its annual dividend is $5 per share, its dividend yield is at a much smaller 1% ($5 ÷ $500 x 100), despite investors receiving a larger dividend amount.
How do Dividends Lead to Long-Term Returns?
Dividends play an integral role in the "total return" of a stock investment.
If a company's stock prices increase by 6% in a year, for instance, this could result in a small return for an investor.
But, if this company then distributes a dividend of 4% in that year too, the stock's total annual return will become 10%, which is much more attractive.
Through this dividend income, you can purchase more stocks, enabling you to grow the value of your holding, through utilizing compounding as a tool in the long run.
Comments