Jan 18th, 2008
Working Backwards: What’s a Dividend?
A dividend is a payment made by a company to its shareholders. It is a part of a company’s profits distributed to those who hold stock in the company. A dividend is typically paid in a fixed amount every quarter in cash. Dividends could take other forms such as property or stock. Unlike interest payments, dividend payments must be approved by the company’s board of directors before each distribution. Companies will pay dividends to their shareholders with a portion of their profits as an alternative to investing those profits back into the company.
Generally, large, established companies are those that pay dividends. Many of the Dow components are dividend payers, such as Altria, Merck, and Wal-Mart. Many investors rely on dividends for part of their income. The dividend yield is the yearly dividend divided by the stock price; for instance, as of this writing, Altria pays a $3.00 dividend each year and has a share price of $76.80, resulting in a dividend yield of 3.9%. The dividend yield allows comparison of dividend paying stocks with each other as well as versus fixed income investments such as money market funds or certificates of deposit.
Some companies have dividend reinvestment programs, also known as DRIPs. The allows stockholders to automatically have their dividends purchase more shares of stocks when they are paid, rather than have a check issues to the stockholder. Some brokerage houses also allow the reinvestment of dividends. Typically the stockholder gets fractional shares of stock when using a DRIP as the dividend will almost never calculate to an exact number of shares.
In the United States, dividends have had a resurgence of popularity in the last few years as qualified dividends are currently taxed at a maximum 15% rate on the federal level. This is often below the investor’s marginal tax bracket, which makes the dividends quite attractive.
One of the things I look for when deciding which stocks to buy is a history of paying dividends. I believe that dividend paying companies tend to be robust and healthy (with exceptions, certainly!) and will survive and hopefully thrive. Dividend paying stocks are among my favorite investments, providing steady income as well as offering the opportunity for growth that fixed income investments simply cannot provide.
Thank you for this explanation of dividends. I vaguely understood the concept, but this helped clarify. I’d love a post discussing the tax issues that arise when investing in a dividend-giving company.
Thanks for your kind words (and for reading!). I read your blog regularly and love your candidness.
Yours is the second request for some tax related postings; it’s not my area of expertise but I will work on getting some things up!
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