Assume you own shares in America’s best tech company. Your parents bought the stock for you when you were born, and you have held it ever since. It is a good company and has made money each year.
Each quarter (four times a year) the company sends you a check. At first it was 5 cents a check. Then it rose to 10 cents and then 15 and now that you are 25 years old and out on your own, you are making a whopping 20 cents every quarter from the single share of stock you own.
So, what are dividends and how often do stocks pay dividends?
What is a dividend?
A dividend is a payment made by a company to shareholders of the company’s stock. Dividends are usually paid quarterly, like a bonus to the holders.
Dividends are a way for shareholders to participate and share in the growth of the company above and beyond the stock price’s appreciation. The more shares you own, the larger your future dividends will be, and the more dividends you reinvest, the more shares you own.
Why companies pay dividends
Companies pay dividends for a number of reasons including:
- Paying shareholders
Dividend payouts are a great way for shareholders to earn a return on their investment even if the share price goes down,
- Making the stock more attractive
Stocks that pay dividends tend to be more attractive than those that don’t, and even in an economic downturn, the stock price doesn’t tumble as much because there is still strong demand.
- Showing stability
Maintaining a record of consistently paying dividends, sends a message about a company’s stability, performance, and future prospects.
- Distributing excess cash
If a company has matured to the point where it has minimal room for capital reinvestment, it may decide to pay the cash out as a dividend of holding huge cash reserves.
However, some companies may not be generating cash or making profits so they simply cannot afford to pay dividends. Others may feel like they have better uses for the cash such as investing in organic growth opportunities, buying back their own shares, making acquisitions, or paying down debt.
Important dividend dates to keep in mind
When trading dividend stocks, there are three important dates traders need to be aware of. They include:
- Ex-dividend date
The ex-dividend date refers to the first trading day a stock trades without its dividend. Traders who buy shares before the ex-dividend date are eligible for the dividend. On the other hand, those who buy shares on or after the ex-dividend date are not entitled to a dividend.
- Record date
This is the date that determines who does and doesn’t get the dividend. Your purchase must settle on or before the date of record for you to receive the dividend. Typically, the record date falls two business days after the ex-dividend date for dividend stocks.
- Pay date
From the company’s standpoint, the pay date is the date when the dividend is actually paid to stockholders. This date has no bearing on who receives a dividend. In short, you will still get your dividend payment on this date if you were a shareholder of record on the date of record, irrespective of whether or not you sell the stock before the pay date.
How often do stocks pay dividends
Most companies across the globe make their dividend-payouts four times a year on a quarterly basis, but some companies pay their dividends monthly, semi-annually (twice a year), annually (once a year), or in rare cases, on no set schedule at all (known as “irregular” dividends).
However, there are no laid out rules dictating how often U.S. companies should pay dividends. That means the companies have the freedom to set their own payout guidelines regarding both the timing and size of their payouts.
Nonetheless, most American corporations traditionally pay their dividends on a quarterly basis, which falls in line with the U.S. Securities and Exchange Commission (SEC)’s requirement to file earnings reports every quarter. Ultimately, the decision of how often dividend payouts will be made lies solely with a company’s board of directors.
How dividends affect share price
Whenever companies declare dividends, the amount can either be lower or higher than anticipated. This can have a huge impact on shares of the companies, and the shares can fluctuate based on the declaration made. Therefore, it is important to understand the relationship between dividends and share prices in detail to help you protect the value of your portfolio.
- When dividends are cut
When a company lowers its dividend payout, the stock becomes less desirable to shareholders. This means that the price of the shares is highly likely to go down.
Not only will shareholders receive a lower dividend, but they will also witness the share price drop. Traders respond very quickly to dividend changes, so even a hint of a dividend cut can send the price down.
- When dividends are increased
If a company raises the dividend it pays on its stock, the stock tends to become more attractive to buyers. That will cause sellers to raise the price in order to generate more profits. Holders of this dividend stock will see the share price will go up as the dividend increases.
However, avoid stocks of companies that raise their dividends without growing profits to make their shares look more desirable, since those firms may not be able to pay the increased dividend as time goes by.
Bottom Line
Dividends are an essential part of stocks as they can weigh on both long- and short-term price movements. They have a significant impact on actual share value and investor sentiment.
In addition, day traders and swing traders can incorporate dividend payouts into their trading strategies, while long-term investors often consider dividends as a primary component of the fair price of a company’s stock.
Historically, stocks that pay dividends have performed better than the broader market. This is simply because, in addition to the growth of the stock itself, shareholders get the extra benefit of dividends.