A dividend is a distribution of a portion of a company’s earnings paid to its shareholders.
How dividends work
When a corporation earns a profit, the management and board of directors decide what to do with that capital. They can reinvest the money back into the business to fund expansion. Alternatively, they can distribute a portion of those profits directly to the shareholders as a dividend. This payment is a direct financial return to investors for providing capital to the business.
Most companies pay dividends in cash by depositing the funds directly into the brokerage accounts of the shareholders. Some companies choose to issue stock dividends, which give investors additional shares instead of cash. The frequency of these payments depends on regional norms and corporate policy. Companies in North America generally pay dividends on a quarterly schedule, while businesses in Europe and Asia often distribute payments semi-annually or annually.
Investors evaluate these payments using a metric called the dividend yield. The yield is the annual dividend per share divided by the current share price. Mature businesses in sectors like utilities or telecommunications are more likely to pay regular dividends. Fast-growing technology companies often retain all their earnings to fund research and do not pay dividends.
The board of directors must approve each dividend payment. They announce the payment amount and establish the ex-dividend date. Shareholders who buy the stock on or after the ex-dividend date do not receive the upcoming payment.
Example
Consider an agricultural company called Trunk Farms that produces massive quantities of peanuts and hay. As fellow Elephants, you might hold 1,000 shares of Trunk Farms in your brokerage account. The company has a profitable year and the board of directors declares a cash dividend of $0.50 per share. On the payment date, Trunk Farms distributes the earnings. Because you own 1,000 shares, you receive a cash deposit of $500 directly into your trading account. You can use this money to buy more shares of Trunk Farms or withdraw the cash to purchase your own peanut supply.