Your favorite publicly traded stock just announced increased dividend payouts. Should you be excited? Skeptical? There’s only one way to know: learning all you can about dividends.
Dividends are cash or stock payouts for shareholders of certain public companies—but that’s just a surface-level explanation. Let’s dig in.
What are stock dividends?
Dividends are payments of cash or additional stock paid out to shareholders of public stocks on a regular basis.
When you buy a share (or shares) of a public company, you become a shareholder (aka a partial owner). When a public company is doing financially well or wants to promote shareholder interest, it may reward stockholders with dividends.
Companies usually pay dividends on a quarterly basis or semiannually, though it depends on the stock at hand how frequently (or not) this happens.
You can find out if a company pays dividends and how much they pay by looking at the dividend yield. This is usually one of the key metrics on a basic stock chart.
Table of Contents:
- What are stock dividends?
- Why buy dividend stocks?
- Why do some companies pay dividends and others do not?
- How often are dividends paid out—and how do shareholders receive them?
- Special dividends vs. regular dividends: Different types of dividends, compared
- Should you automatically reinvest dividends?
- Taxing stock dividends: What to know
- How to choose the right dividend stock to invest in
- How to invest in dividend stocks on Public.com
- Bottom line on dividend stocks
- FAQs
Why buy dividend stocks?
Many investors use dividends as a form of passive income. The only prerequisite of receiving a dividend is being a shareholder of a dividend-paying company.
The caveat? Public companies may use dividends to court investors even when the stock price is decreasing.
Additionally, these companies are not required to pay dividends to shareholders. A company’s board of directors can decide to issue, cut back on, or eliminate dividends at any time. This is true even for stocks with consistent dividend payouts over a period of years or decades.
Still, dividend income is a legitimate income stream. Just remember that past performance is not an indicator of future results.
Explore high yield dividend stocks in 2023 and understand the reasons behind investing in dividend stocks, check out this article that highlights a list of public companies offering dividend yields of 3% or higher, providing valuable insights into the potential benefits of dividend investing.
Why do some companies pay dividends and others do not?
Paying dividends is often a sign of financial health. Dividends signal to investors that the company has excess profits that they are willing to give to shareholders. Therefore, it is uncommon (but not impossible) for a non-profitable company to offer dividends.
This does not mean that a company’s success is contingent on them offering dividends to shareholders. Young startups often don’t pay dividends because they need to reinvest all of the company’s profits back into itself to fuel high growth.
For this reason, you will see that dividends are more common among mature companies. You may also see them in certain stocks that fall under the category of “blue chip.” Blue-chip stocks are public companies that are huge, mature, and have a solid reputation.
While dividend payments are often a good sign, it is important to note that extremely high dividend payments could be a red flag.
Higher dividend payouts are difficult to sustain over a long period, so a person who invests in a company with high dividends accepts the risk of the company cutting back or eliminating payments at any time (as well as the natural risk of value loss in any stock).
How often are dividends paid out—and how do shareholders receive them?
The timing of a dividend payout differs from company to company. The most common cadence is quarterly. Some Real Estate Investment Trusts (REITs—pronounced “reets”) pay dividends monthly.
Jargon Alert!
A declaration date is the date a company announces it will distribute dividends to investors.
An ex-dividend date (aka ex date) is the set deadline for dividend payouts to existing shareholders. The company owes dividends to any shareholders who buy the stock before that date. The company does not owe dividends to any shareholders who buy the stock on or after the ex date.
The payment date is when the company actually distributes dividend payouts.
A dividend payment can come in one two forms:
- Stock: A stock dividend pays an investor with additional shares of stock. For example, if an investor owns 20 shares of a company that pays a 5% stock dividend, the investor will receive 1 additional share as annual dividend payment (5% of 20 = 1).
- Cash: A cash dividend pays investors with cash. For example, if an investor owns 20 shares at $10 each ($200 in total value) and the company offers a 5% cash dividend, the investor will receive $10 as annual dividend payment (5% of $200 is $10).
For both stock and cash dividend payouts, you will receive the dividend payment on the payout date in your brokerage account. Some people choose to pocket dividends, but some people choose to reinvest their dividend payments back into the company.
The way a dividend is paid out may depend on what class of stock you own (aka preferred or common stock). As the name implies, preferred stock shareholders have priority over common stock shareholders. Preferred dividend stockholders usually receive their dividends earlier than common stockholders.
Did you know? If a company decides to skip a dividend payment they may be obligated to pay back this dividend in the future to preferred stock shareholders. They do not have this obligation to common stock shareholders.
Understanding the dividend payout ratio
The dividend payout ratio, aka dividend yield, shows you the proportion of the company’s earnings that the company pays out to shareholders as a dividend.
The dividend yield you see on a stock chart looks like a percentage (for example, some dividend-paying companies in the S&P 500 may have dividend yields around 2–5%, depending on the company and sector).
Here’s a simple equation to remember dividend payout ratio:
Dividend Payout Ratio = Dividends Paid / Net Income
Special dividends vs. regular dividends: Different types of dividends, compared
Most dividends are regular, meaning companies pay them out on a consistent cadence. But that’s not always the case.
A special dividend is a non-recurring dividend. It may only be a one-time event and is not suggestive of long-term dividend payouts. You can find out if a dividend announcement is special or regular by looking up a stock’s dividend history on the Nasdaq website.
Should you automatically reinvest dividends?
Whether or not you want to automatically reinvest your dividend payouts into the company is up to you. Many investors will select this option if the stock shows signs of long-term growth. It can be an effective way to get compounded returns, aka cumulative growth from a series of gains and reinvestments.
The process of automatically reinvesting dividends is also called a dividend reinvestment plan (DRIP).
Did you know? The Public app offers automated dividend reinvesting. When you use this feature, we’ll invest any dividends you receive right back into the company that paid it out. This helps you build an effective habit and automatically compound your money over time.
Taxing stock dividends: What to know
Qualified dividends are subject to a capital gains tax, which can be lower than the federal income tax if you hold the stock position for a year or more.
There are two types of capital gains tax: Short-term and long-term capital gains.
Typically, the Internal Revenue Service (IRS) applies short-term capital gains to investments held for less than a year before selling. The IRS usually applies long-term capital gains to investments held for a year or more.
But it treats dividends differently.
Whether a cash dividend is qualified or non-qualified will determine what tax structure will apply.
A dividend is considered qualified if common stock is held for a minimum of 60 days or preferred stock is held for a minimum of 90 days before the ex-dividend date. If a dividend is qualified it is subject to the long-term capital gains tax rate, which is considerably less than the federal income tax rate. If a dividend is non-qualified, the capital gains tax does not apply and it is subject to the investor’s ordinary income tax rate (which depends on their tax bracket).
The long-term capital gains tax rate can either be 0%, 15% or 20% based on your annual income and marital status, whereas the federal income tax rate can fall anywhere between 10% to 37%. Within any income and marital bracket, a person will earn more after a long-term capital gains tax than they would after a federal income tax. For the diligent investor, dividends can provide great tax opportunities.
Even if you receive dividends in the form of stock or automatically reinvest your dividends, you still must pay taxes. The one exception to this is if you’re earning dividends in a tax-advantaged retirement account (such as an IRA).
How to choose the right dividend stock to invest in
Look at past performance on stock charts through the Public app. Determine how consistent dividend payouts are over the quarters and years. Compare that to the stock price fluctuations during this time. Decide if the opportunity for dividend earnings outweigh the risks associated with the stock investment.
Common dividend stock investing strategies
If you want to implement an investment strategy focusing on high-yield dividend stocks, you’re not alone. Many people earn regular income through dividend stocks, but they still must make their own investment decisions.
As a dividend investor, you must ask yourself…will you:
- Reinvest dividends to buy more shares of the same company?
- Use those dividends to buy stock in a different company?
- Save the cash?
- Withdraw and spend the money?
Be wary of anyone giving you cut-and-dry investment advice. Tailor your strategy to your own life, including current market conditions and your personal financial needs and goals.
How to invest in dividend stocks on Public.com
Invest in dividend stocks on the Public platform the community value of the social investing app is well above par. It’s beneficial for investors who want to gain insight on what other investors are seeing and doing in the market, to help gather information to build their own strategy.
If you’re looking for dividend investments specifically, you can connect with people who focus on dividends. Additionally, look at stock charts and find ones with relatively consistent dividends. If you’re not ready to invest yet, simply add them to your watchlist.
Public Premium users gain access to advanced company insights and metrics, plus access to Morningstar research reports.
Finding sustainable dividend stocks on Public
Quick tip: If you’re an impact investor, you may want to invest with the planet in mind. You can find sustainable dividend stocks on the Public app by looking at themes. For example, search through green power stocks to find ones that pay out dividends.
Bottom line on dividend stocks
Dividend stocks provide passive income for shareholders. With the right stocks, they can help investors generate wealth over the long term. In some cases, dividends signal a company’s financial health. In other cases, it’s a distraction from the share price. But in general, dividends are an effective addition to a broadly diversified portfolio.
Remember: Dividends are never promised, but a dividend investing strategy can still provide a valid form of passive income when done right.
Frequently asked questions
Can you use dividends to generate passive income?
Yes, some investors use dividends to generate passive income stream over the long term.
How long do I have to hold a stock to get the dividend?
You must buy the stock prior to the date of record, which is the set date shareholders must be invested by in order to get paid for the upcoming quarterly or monthly dividend.
How do I take my dividends?
You can take your dividends as cash or stock, depending on what the company offers. If you get cash dividends, you can withdraw or reinvest into the company.
Can I get dividends from ETFs and mutual funds?
Some exchange traded funds (ETFs) and mutual funds pay dividends. These funds are baskets of stocks and securities, so you may receive dividends on any stocks within the fund that pay dividends. Dividend-themed funds will likely have higher dividend payouts.