Facts About Dividends (2024)

What Are Dividends?

"Money for Nothing" is not only the title of a song by the band Dire Straits from the 1980s, but it is also the feeling many investors get when they receive a dividend. All you have to do is buy shares in the right company, and you'll receive some of its earnings. How exciting is that?

Dividends are one way in which companies "share the wealth" generated from running the business. They are usually a cash payment, often drawn from earnings, paid to the investors of a company—the shareholders.

These are paid on an annual, or more commonly, a quarterly basis. The companies that pay them are usually more stable and established, not "fast growers." Those still in the rapid growth phase of their life cycles tend to retain all the earnings and reinvest them into their businesses.

Key Takeaways

  • A dividend is usually a cash payment from earnings that companies pay to their investors.
  • Dividends are typically paid on a quarterly basis, though some pay annually, and a small few pay monthly.
  • Companies that pay dividends are usually more stable and established, not those still in the rapid growth phase of their life cycles.
  • Dividends have different tax and pricing implications for individuals and companies.

Understanding Dividends: Price Implications

When a dividend is paid, several things can happen. The first of these are changes to the price of the security and various items tied to it. On the ex-dividend date, the stock price is adjusted downward by the amount of the dividend by the exchange on which the stock trades.

For most dividends, this is usually not observed amidthe up-and-down movements of a normal day's trading. It becomes easily apparent, however, on the ex-dividend dates for larger dividends, such as the $3 payment made by Microsoft in the fall of 2004, which caused shares to fall from $29.97 to $27.34.

The reason for the adjustment is that the amount paid out in dividends no longer belongs to the company, and this is reflected by a reduction in the company's market cap. Instead, it belongs to the individual shareholders. For those purchasing shares after the ex-dividend date, they no longer have a claim to the dividend, so the exchange adjusts the price downward to reflect this fact.

Historical prices stored on some public websites also adjust the past prices of the stock downward by the dividend amount. Another price that is usually adjusted downward is the purchase price for limit orders.

Because the downward adjustment of the stock price might trigger the limit order, the exchange also adjusts outstanding limit orders. The investor can prevent this if their broker permits a do not reduce (DNR) limit order. Note, however, that not all exchanges make this adjustment. The U.S. exchanges do, but the Toronto Stock Exchange, for example, does not.

On the other hand, stock options prices are usually not adjusted for ordinary cash dividends unless the dividend amount is 10% or more of the underlying value of the stock.

Implications for Companies

Dividend payments, whether cash or stock, reduce retained earnings by the total amount of the dividend. In the case of a cash dividend, the money is transferred to a liability account called dividends payable. This liability is removed when the company makes the payment on the dividend payment date, usually a few weeks after the ex-dividend date.

For instance, if the dividend was $0.025 per share, and 100 million shares are outstanding, retained earnings will be reduced by $2.5 million, and that money eventually makes its way to the shareholders.

In the case of a stock dividend, however, the amount removed from retained earnings is added to the equity account, common stock at par value, and brand new shares are issued to the shareholders. The value of each share's par value does not change.

For instance, for a 10% stock dividend where the par value is 25 cents per share, and 100 million shares are outstanding, retained earnings are reduced by $2.5 million, common stock at par value is increased by that amount and the total number of shares outstanding is increased to 110 million.

This is different from a stock split, although it looks the same from a shareholder's point of view. In a stock split, all the old shares are called in, new shares are issued, and the par value is reduced by the inverse of the ratio of the split.

For instance, if instead of a 10% stock dividend, the above company declares an 11-to-10 stock split, the 100 million shares are called in, and 110 million new shares are issued, each with a par value of $0.227. This leaves the common stock at par value account's total unchanged. The retained earnings account is not reduced either.

Implications for Investors

Cash dividends, the most common sort, are taxed at either the normal tax rate or at a reduced rate of 20%, 15%, or 0% for U.S. investors. This only applies to dividends paid outside of a tax-advantaged account such as an IRA.

The dividing line between the normal tax rate and the reduced or "qualified" rate is how long the underlying security has been owned. According to the IRS, to qualify for the reduced rate, an investor has to have owned the stock for 60 consecutive days within the 121-day window centered on the ex-dividend date. Note, however, that the purchase date does not count toward the 60-day total. Cash dividends do not reduce the basis of the stock.

Corporations can be investors, too. When corporations invest in other dividend-paying companies, they may exclude a portion of the dividend income they receive. This deduction avoids the double taxation of income.

Capital Gains

Sometimes, especially in the case of a special, large dividend, part of the dividend is declared by the company to be a return of capital. In this case, instead of being taxed at the time of distribution, the return of capital is used to reduce the basis of the stock, making for a larger capital gain down the road, assuming the selling price is higher than the basis.

For instance, if you buy shares with a basis of $10 each and you get a $1 special dividend, 55 cents of which is return of capital, the taxable dividend is 45 cents, the new basis is $9.45 and you will pay capital gains tax on that 55 cents when you sell your shares sometime in the future.

There is a situation, though, where return of capital is taxed right away. This happens if the return of capital would reduce the basis below $0. For instance, if the basis is $2.50 and you receive $4 as a return of capital, your new basis would be $0, and you would owe capital gain tax on $1.50.

The basis is also adjusted in the case of stock splits and stock dividends. For the investor, these are treated the same way. Taking our 10% stock dividend example, assume you hold 100 shares of the company with a basis of $11. After the payment of the dividend, you would own 110 shares with a basis of $10. The same would hold true if the company had an 11-to-10 split instead of that stock dividend.

The Bottom Line

Finally, as with everything else regarding investment record keeping, it is up to individual investors to track and report things correctly. If you have purchases at different times with different basis amounts, return of capital, stock dividend, and stock split basis adjustments must be calculated for each.

Qualified holding times must also be accurately tracked and reported by the investor, even if the 1099-DIV form received during tax season states that all paid dividends qualify for the lower tax rate. The IRS allows the company to report dividends as qualified, even if they are not, if the determination of those that are qualified and those that are not is impractical for the reporting company.

Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circ*mstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal. Investors should consider engaging a qualified financial and/or tax professional to determine a suitable investment strategy.

Facts About Dividends (2024)


What is a fact about dividends? ›

They are usually a cash payment, often drawn from earnings, paid to the investors of a company—the shareholders. These are paid on an annual, or more commonly, a quarterly basis.1 The companies that pay them are usually more stable and established, not "fast growers."

Why dividends are good? ›

First, they provide a regular income stream, which can be especially attractive to income-focused investors such as retirees. Second, dividends are often seen as a sign of a company's financial health and stability, as they indicate that it's generating enough profits to distribute at least some to shareholders.

How do dividends work? ›

Cash dividends are paid out either as a check sent to the investor or as a credit to a brokerage account, which can then be reinvested. Stock dividends are paid in fractional shares. If a company issues a stock dividend of 5%, shareholders will receive 0.05 shares in dividends for every share they already own.

What do dividends tell us? ›

However, dividends are more likely to be paid by well-established companies that no longer need to reinvest as much money back into their business. As a result, stocks that pay dividends can provide a stable and growing income stream. Dividends are considered an indication of a company's financial well-being.

What is true about dividends? ›

Answer: Dividends are a distribution of cash, stock, or other assets to the stockholders. Explanation: Dividends are a payment to shareholders out of a company's retained earnings. If retained earnings are 0 then it is a return of capital rather than a dividend.

What causes dividends? ›

Various mutual funds and exchange-traded funds (ETFs) also pay dividends. A dividend is a reward paid to the shareholders for their investment in a company's equity, and it usually originates from the company's net profits. For investors, dividends represent an asset, but for the company, they are shown as a liability.

Why do dividends still matter? ›

As dividends are a form of cash flow to the investor, they are an important reflection of a company's value. It is important to note also that stocks with dividends are less likely to reach unsustainable values. Investors have long known that dividends put a ceiling on market declines.

Why is dividend necessary? ›

Dividends are one way companies can attract more investors. Investing in the stock market can be a great way to build long-term wealth. It can also be an income stream for some investors, depending on the kind of assets they invest in.

What are the pros and cons of dividends? ›

The Pros & Cons Of Dividend Stock Investing
  • Pro #1: Insulation From The Stock Market. ...
  • Pro #2: Varied Fluctuation. ...
  • Pro #3: Dividends Can Provide A Reliable Income Stream. ...
  • Con #1: Less Potential For Massive Gains. ...
  • Con #2: Disconnect Between Dividends & Business Growth. ...
  • Con #3: High Yield Dividend Traps. ...
  • Further Reading.
Nov 22, 2023

What is a dividend example? ›

The distributions are paid in fractions per existing share. For example, if a company issues a stock dividend of 5%, it will pay 0.05 shares for every share owned by a shareholder. The owner of 100 shares would get five additional shares.

Do dividends make you money? ›

Dividends can have a big impact on your portfolio over time. They can help generate income during retirement or earlier and can also be reinvested to increase your total investment return.

Who pays dividends? ›

Dividend distributions – usually made in cash but occasionally paid out in shares – are payments made by public companies to stockholders. There are many good reasons savvy investors own dividend-paying stocks. Dividends are a direct and tangible way for investors to benefit from the earnings a company generates.

What are dividends good for? ›

The relationship between dividends and market value

They may provide some hedge against inflation, especially when they grow over time. They are tax advantaged, when compared to some other forms of income, such as interest on fixed-income investments.

What is the goal of dividends? ›

Dividends represent the distribution of corporate profits to shareholders, based upon the number of shares held in the company. Shareholders expect the companies that they invest in to return profits to them, but not all companies pay dividends.

Why are dividends important to people? ›

Five of the primary reasons why dividends matter for investors include the fact they substantially increase stock investing profits, provide an extra metric for fundamental analysis, reduce overall portfolio risk, offer tax advantages, and help to preserve the purchasing power of capital.

What is a fact about dividend in math? ›

The dividend is the number that is being divided. The number that is doing the dividing is the divisor. The quotient is the answer to a division problem, or the number of times the divisor goes into the dividend evenly. The remainder is what is left over, if anything, after dividing.

What is an example of a dividend? ›

For example, if a company issues a stock dividend of 5%, it will pay 0.05 shares for every share owned by a shareholder. The owner of 100 shares would get five additional shares.

What describes a dividend? ›

A dividend is a company's payment, based on profit, to the people who own stock in the company. Dividend payments are based on the class of the stock, the stock price and the number of shares an investor has in a company. Dividends are frequently paid in cash to investors but may come in other forms of compensation.


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