Dividend definition
“A dividend is a partial payment of a company’s profits,” said Frank Murillo, the managing director at Snowden Lane Partners in Miami. “Some companies choose to pay them, some do not. Those that do not will typically choose to retain that portion of the profits and reinvest them in the growth of a company.”
If you invest in a company stock, you may earn money from dividends paid by that company. Dividend earnings can come in the form of a cash deposit or be reinvested into the company to buy more stock. Dividend payments are given out on a regular schedule (typically quarterly).
The amount you earn is calculated as a percentage of the stock price and is known as “yield.” This lets investors know how much will be paid per year.
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How do dividends work?
When a company makes enough money to cover its costs and earn a profit, it can choose to share some of those earnings with investors in the form of dividends. The board of directors is responsible for deciding how much the dividend is and in what form.
Why do companies pay dividends?
Dividend-paying stocks are seen as a more stable investment and give investors confidence in the company’s financial position.
Which stocks pay dividends?
Some market sectors pay more dividends than others. Some of the higher-dividend markets include:
- Financial
- Basic materials
- Utilities
- Consumer goods
- Services
In addition, real estate investment trusts (REITs) are required to pay out at least 90% of their taxable income as dividends.
When are dividends paid?
What is dividend yield?
Dividend example
- Company: Black Hills Corp. (BKH)
- Share price: $50.59
- Forward dividend: $2.50 ($0.625 per quarter)
- Dividend yield: 4.94%
This company is offering a dividend each quarter of $0.625 per share owned, for a total of $2.50 per year. Divided by the average share price, this results in an estimated yield of 4.94%.
This means that shareholders can expect a $2.50 dividend payment for every share they own. If an investor owns 100 shares of BKH, they can expect $250 per year in dividend payments.
Types of dividends
These are the different types of dividends that can be paid out by a company:
- Cash dividends are paid to investors in the form of cash deposited into a shareholder’s brokerage account.
- Stock dividends are paid to investors in the form of more company stock.
- Reinvested dividends are an option for investors to reinvest dividend payments back into company stock. This is known as a DRIP, or a dividend reinvestment plan.
- Special dividends are nonrecurring dividend payments that are usually the result of excess retained earnings or unexpected profits.
- Preferred dividends are dividend payments to preferred stock owners. Preferred stock owners don’t share in corporate profits but instead get a fixed dividend payment.
How to invest in dividend stocks
You can buy dividend stocks at most major brokers, as well as through investing apps.
- Open an account. Pick your favorite stock investing app or online broker.
- Fund your account. Deposit money into your account to use for investing.
- Research dividend stocks. Find a few you like and want to buy, and compare them. Most brokers offer a stock screener to filter by dividend stocks.
- Purchase dividend stocks. Most brokers offer commission-free stock trades, so you can buy the dividend stocks you like without extra fees.
- Wait. Once you own a dividend stock, you can just wait until the next dividend payment.
Note that you must purchase the dividend stock before the ex-dividend date to receive the next dividend payment. This date is listed in the stock details, and you must own the stock at least one day prior to the ex-dividend date.
Dividend tax rate
In most cases, dividend payments are treated as ordinary income. This means they are taxed at your regular income tax rate. For example, if you receive dividends throughout the year and your income tax rate is 22%, you’ll pay that rate on your dividend income.
But qualified dividends are treated differently and are taxed at long-term capital gains tax rates. A qualified dividend is a dividend payment from an eligible share of stock held at least 61 days out of the 121-day period that began 60 days before the security’s ex-dividend date.
For example, if you bought a dividend stock on March 15, 2023, and the ex-dividend date was May 31, 2023, the dividends received after that may be considered qualified dividends. Not all dividends can be qualified dividends.
This means those dividends are taxed at a 0%, 15% or 20% tax rate, depending on your taxable income for the year. This can be a significant savings in taxes over ordinary income tax rates.
» MORE: Capital gains vs. investment income: how they differ
FAQ
Do all stocks pay dividends?
No. Many stocks don’t pay out dividend payments. This can be due to financial troubles, low profits or the company wanting to reinvest profits back into itself for growth. You can find out if a stock pays dividends by checking for a listed dividend payment or yield percentage.
What stock pays the highest dividend?
Financial stocks, utility stocks and natural resources are known for paying high dividends. As of publishing, some of the highest-paying dividend stocks in the S&P 500 include KeyCorp (KEY), Truist Financial Corp. (TFC), AT&T Inc. (T) and Pioneer Natural Resources Co. (PXD).
What is a good dividend yield?
A good dividend yield is between 2% and 4%, as lower yields mean less income, and higher yields might mean more risk. Companies that pay 8% yield or higher might have a plummeting stock price, causing yields to show higher. So it’s important to research a company before investing instead of just looking at the dividend yield.
Do dividends count as income?
Yes. Dividends count as ordinary income and are taxed as such, unless they are qualified. Qualified dividends require a longer holding period and must be bought long before the ex-dividend date. And some stocks, such as REITs, are not eligible for qualified dividends.
Bottom line
Dividend investing is a popular way to earn passive income. You can simply invest in a stock, wait a while, and collect regular payments for holding it.
But just because a company pays a high dividend does not make it a good investment. It’s important to research any company before investing in its stock and make sure it fits your investing goals, risk tolerance and timelines. Also, consider the tax implications before investing heavily in dividend-paying stocks.
Article sources
- PwC, “4.4 Dividends.” Accessed Sept. 26, 2023.
- Securities and Exchange Commission, “Investor Bulletin: Real Estate Investment Trusts (REITs).” Accessed Sept. 26, 2023.
- IRS, “Investment Income and Expenses.” Accessed Sept. 26, 2023.
